My younger brother is developing an interest in the stock market. He asked me for advice recently.
"Only buy small companies," I told him.
On Wall Street, brokers and analysts judge the size of a company by its market capitalization. A company's "market cap" is simply the stock market's best estimate of a company's total value.
Generally speaking, brokers call any company with a market cap under $1 billion a "small-cap stock" and any company with a market cap under $250 million a "microcap stock." (It's also common to refer to both groups as "penny stocks" because in the past, these small-cap stocks often traded for less than a dollar per share. These days, very few stocks actually trade for pennies, but they're called penny stocks anyway.)
If you're serious about making a fortune in the stock market, I recommend you only buy small caps and microcaps...
For one thing, Wall Street and big funds cannot invest in small-cap stocks. It's a liquidity problem. Micro investments can't offer meaningful profit opportunities to large investors. There's a practical problem, too. Micro stocks are thinly traded. It's impossible for them to take large positions without pushing the price up.
So in general, the "big money" ignores small-cap stocks. And because the fund managers aren't interested, the investment banks don't bother researching these companies... and the press ignores them, too.
Dozens of analysts and traders follow the large companies. The market for large stocks is efficient. There are rarely pricing anomalies or bargains. But the small-cap market is full of pricing anomalies, undervaluation, and inefficiencies. So you can find true values among small caps.
For another thing, you have mathematics on your side when you buy a small-cap stock. You don't buy stock in a giant company like McDonald's or Coca-Cola and expect to quadruple your money in a few years. These companies are so big, there's simply no way they can grow fast enough to produce 200%, 300%, and 500% gains.
Small-cap stocks generate returns (and losses) of this magnitude all the time. I can list dozens of stocks that have risen more than 1,000% in the past nine months.
But for me, the most compelling reason to own small caps is because we've just pulled out of a recession. At the end of every major market downturn, small stocks rise higher and faster than any other investment in the world on the way back up...
I have What Works on Wall Street by James O'Shaughnessy in front of me. It compares the performances of small-cap stocks with the S&P 500. Following the 1973-74 bear market, small-cap stocks had risen 447% six years later versus only 264% for the S&P 500.
In 2003, as the markets recovered from the bear market of 2001, small stocks outpaced all others by a nearly two-to-one margin. The same story repeated in 2009.
Now, if you're retired and your investment goals are to preserve your capital and make low-risk income, then I wouldn't recommend small-cap stocks. They're too volatile. Small-cap stocks are best suited for aggressive investors... like my younger brother. He's 22 years old and can handle the large dips you get with small-cap stocks.
He didn't ask me for more specific advice on how to pick stocks, but if he had, I would have told him to pick companies that have rising stock prices, always use a trailing stop loss, and favor companies in boring industries that produce lots of cash.
Good investing,
Tom
P.S. I write a newsletter dedicated to finding "penny stock" investments. We look for penny stocks making new highs, telling us they are in bull markets, and we jump on board. To learn about a trial subscription, click here.
Our favorite member of the "unlikely new highs" club is becoming its new leader.
Back in November, we covered the upside breakout in the iShares Healthcare Providers Fund (IHF). This fund is a one-click way to buy a diversified basket of America's largest health care businesses. Major weightings include DaVita (dialysis), Aetna (insurance), Laboratory Corp (testing), Express Scripts (pharmacy management), and Covance (drug development).
Months ago, conventional wisdom said the health care industry's profit margins would be pressured by government bureaucrats. But as our colleague Rob Fannon commented, a "free health care for everyone" system would create a ton of new demand. After all, nobody can spend money like Uncle Sam. This demand will drive health care stocks higher for years.
As you can see from today's chart, the market likes this thesis. The IHF is enjoying one of the steadiest, strongest uptrends in the market right now. Shares have climbed from $42 to $51 in just three months. Millions of customers, who couldn't care less about cost (after all, their neighbors are paying for it), are headed its way...
Today, I'm going to share several of my favorite technical indicators and patterns. Becoming familiar with them will help you to spot the best trading opportunities in the market.
