Me, I was working on a column a lot like this one. In fact, it was just like this one. And looking back, I may have stumbled on two facts that could have made us both a lot of money.
And you can still cash in
So, just to be safe, I think I'll repeat them right now:
- 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're 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 declaring the small-cap rally dead. I didn't buy it (and I hope you didn't, either).
Instead, 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 still had time to get in yourself and still profit. If you did, you're sitting on another 52% 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 noting. First, we were coming out of a recession, and small-cap growth stocks are notoriously hot during recoveries. More importantly, we hadn't nearly made up the ground lost during the '90s mega-cap lovefest.
Don't sleep on this last point. I catch grief for constantly pointing out how difficult it would be for a massive operation like Ford
Even if Ford did double its revenues, the stock could still let you down. After all, look at large-cap stalwarts like Eli Lilly
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. Small companies are simply more agile and better poised for growth than the behemoths we hold in our "total market" index funds.
Which is why I'm a fan of Tom Gardner's Motley Fool 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.
Plus, 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, even so-called "total market" funds. In fact, these funds are dominated by large-cap growth stocks. Which means that, among other things, you're holding a lot more $82 billion old-school Time Warner
Put another way, you may think you own equal chunks of 3,736 stocks, but you don't. Even in a so-called total market fund, you'll always have much more exposure to a $112 billion ConocoPhillips
In fact, just 10 massive stocks make up more than 15% of your "total market" portfolio. That's why yesterday's sell-off in Pfizer sent you running for the Alka-Seltzer, while today's 25%-plus pop in tiny Direct General
Famous last words
Even if you agree that megacaps 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 with Pfizer or ConocoPhillips, 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 Dec. 4, 2006, the picks are up 44.5%, versus 20.5% if you'd bought the S&P 500 instead. You can view them all on our scorecard with yourfree trial. Paul owns iShares S&P SmallCap 600 ETF. Wal-Mart and Pfizer are Inside Value picks. Time Warner is a Stock Advisor recommendation. Eli Lilly is an Income Investor recommendation. The Motley Fool has adisclosure policy.