Where were you on the evening of Sept. 26, 2003? And did you have more money than you have now ... or less?
Me, I was working on a column like this one. And looking back, I may have stumbled on two facts that could have made us both some money.
Don't worry, you can still cash in
In case you weren't with us back in 2003, I'll give you a quick recap. You see, I think the bull case is as compelling today as it was then.
- I still don't believe the rally in small-company stocks is kaput.
- If you don't have small stocks in your portfolio, don't assume you're covered by your mutual funds. Not even so-called "total market" funds.
I'll explain why in a moment. But first, back to September 2003, when a lot of "experts" were driving the nail in the small-cap rally's coffin. I didn't buy it then (and I hope you didn't, either).
Instead, I boasted how I had loaded up on the iShares S&P SmallCap 600 Growth (IJT) the previous January at around $65. Then, I suggested you still had time to buy it yourself and make some money. If you did, you're sitting on another 70% gain. And that's on a diversified index. Well done.
Why you should keep it small
I won't rehash my entire argument, 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 such as Eli Lilly
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. Small companies are 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, Tom invests from the bottom up. When you focus on specific companies, you don't need across-the-board strength in a sector or investment style. And with small caps, you get another bonus -- if you know how to play it.
There's less information on smaller, more thinly traded stocks. As a result, the market is less efficient, and, 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 even if you own 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 $118 billion ConocoPhillips -- and energy stocks in general -- than you may think. As for No. 3,736 (whatever that is), you barely have any.
In fact, just 10 massive stocks make up more than 15% of your "total market" portfolio. That's why yesterday's modest jump in Citigroup
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 with Time Warner or ConocoPhillips, an extra $1 billion in earnings could propel you into a whole new tax bracket.
If you agree that sounds like some sweet action, you should give Hidden Gems a try. 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.
So, if you're looking for small-cap ideas and advice, that's where I'd start. In fact, you can take a free trial starting right now and check out all Tom's picks. If you're not impressed by what you see, simply don't subscribe and don't pay a penny. 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 May 17, 2007, the picks are up 59.7%, versus 26.3% if you'd bought the S&P 500 instead. You can view them all on our scorecard with your free trial. Paul owns iShares S&P SmallCap 600 ETF. Wal-Mart is an Inside Value pick. Time Warner is a Stock Advisor recommendation. Eli Lilly is an Income Investor recommendation. The Motley Fool has a disclosure policy.
