Me, I was working on a column a lot like this one. In fact, it was just like this one. In September 2003, I stumbled on two facts that could have made us both a lot of money.
And you can still cash in
Allow me to repeat them:
- I still don't believe the historic rally in small-company stocks is kaput.
- If you don't have small companies in your portfolio, don't assume you're covered by your mutual funds. Not even if they are so-called total market index funds.
I'll explain why in a moment. But first, back to September 2003, when a lot of "experts" were already clamoring that the money had been made and the small-cap rally was cooked. I jumped at the bait (and I hope you did, too).
First, I confessed to having loaded up on the iSharesS&P SmallCap 600 Index (IJT) the previous January -- at around $65 for a quick 25% gain. Next, I suggested that you could still buy this low-cost small-cap index yourself and still make out. If you did, you're sitting on another 50% gain. Well done.
Why you should keep it small
I won't rehash my argument for why I liked small caps then, but a few points are worth touching on. First, we were coming out of a recession, and small-cap growth stocks are notoriously hot during recoveries. Second, we hadn't nearly made up the ground lost during the '90s mega-cap lovefest.
And don't sleep on this last point. I catch grief for constantly pointing out how difficult it would be for a massive operation like Intel
Even if Intel did double its revenues, the stock could still let you down. In fact, revenues and earnings have been solid -- not only for Intel, but also for giants like Wal-Mart
But
we're
just getting buzzed
Plus, even if I am irrationally exuberant about small caps, it's not the end of the world. In my view, the advantages of small companies extend beyond relative valuations. By definition, small companies are more agile and better poised for growth than the behemoths we hold in our "total market" funds.
Which is why I'm a fan of Tom Gardner's Hidden Gems approach. For one thing, he invests from the bottom up. When you focus on specific companies, you don't need to rely on across-the-board strength in a sector or investment style. And if you focus on small caps, you get another bonus -- if you know how to play it.
There's less information out there on smaller, more thinly traded stocks, making the market less efficient. Moreover, as Tom is fond of explaining, the lack of interest in these stocks keeps you out of crowded auction-house bidding wars like the one that broke the bank for large-cap investors in 2000.
Finally, the problem with your mutual funds
Don't assume you're covered because you own broad market stock funds, oreven so-called total market funds. In fact, these funds are dominated by large-cap growth stocks. Which means that you're vastly overweight in $190 billion Johnson & Johnson
Worse, because the index is weighted by market cap, your tail is wagging your dog. How so? Well, you may think you own an equal chunk of 3,756 stocks, but not so. You've really got a ton of $250 billion Bank of America
As for No. 3,756 (whatever that is), you barely have a sliver. In fact, just 10 massive stocks make up more than 15% of your "total market" portfolio. That's why a big sell-off in Wal-Mart sends you running for the Alka-Seltzer, while the best day in the history of No. 3,756 (whatever that is) barely buys you lunch.
Famous last words
Even if you agree that mega caps are due, you still shouldn't dump your small-cap stocks. History proves that many (if not all) of tomorrow's Goliaths are Davids today. And unlike Bank of America or JPMorgan, an extra $1 billion in earnings could propel you into a whole new tax bracket.
If that sounds like some sweet action, you should give Hidden Gems a holler. Tom and his analysts have already turned up a dozen or so stocks that doubled in value or more. And he has me convinced that a 10-bagger might be on his buy list already.
If you're looking for small-cap ideas, that's where I'd start. In fact, you can check out all Tom's picks the instant you start your trial. If you're not impressed by what you see, simply don't subscribe. To have a look, click here.
This article was originally published on March 24, 2006. It has been updated.
Fool contributor Paul Elliott promises to keep you posted on the progress at Hidden Gems. As of Oct. 5, 2006, the picks are up 33%, versus 16% if you'd bought the S&P 500 instead. You can view them all on the Scorecard with yourfree trial. Paul owns shares of Bank of America and the iShares S&P SmallCap 600 ETF. Bank of America, Johnson & Johnson, and JPMorgan are Income Investor picks.Intel and Wal-Mart are Inside Value picks. The Motley Fool has adisclosure policy.
