BEING STREET SMART
by Sy Harding
It's Small-Stock Sweet Spot Time!
December 9, 2011.
Some investing truisms are pure baloney. For instance, that
you can rely on the stock market returning 10% to 12% per year on average. That
if you want higher profits you have to take more risk. That you can’t time the
market. That election years are always positive for the stock market.
But there are some that can be very useful. The market is
almost always higher in April than in September (annual seasonality). The market
performs significantly better with a Democrat in the White House (so says the
data of the last 100 years). The market tends to experience most of its serious
corrections in the first two years of a new President’s term (and if it doesn’t,
watch out in year three or four).
One that is about to enter its zone is the tendency for
small stocks to outperform the market from mid-December to mid-January.
It used to be known as the ‘January effect’, but in recent
years the pattern has tended to begin in mid-December. The theory behind it is
that there’s a considerable amount of tax-loss selling in small stocks toward
year end, which drives their prices down, and sets them up for bargain hunters.
The tendency is for small stocks to often continue to outperform larger stocks
into the spring.
One that I like is MTS Systems, symbol MTSC, Nasdaq, $40.25,
small cap (15,800,000 shares). The company provides systems for testing and
examining the mechanical behavior of materials, products and structures, as well
as instrumentation for factory automation. The company’s sales and earnings slid
significantly in the recession, but have been roaring back this year. Earnings
over the last four quarters more than doubled on a 20% sales increase. The
company is experiencing solid backlog growth, which bodes well for next year.
Meanwhile, solid cash flow has allowed the company to increase its dividend, as
well as to accelerate a share repurchase plan. MTSC has roughly $100 million in
cash and no long-term debt, and sells at just 12.5 times trailing earnings.
I also like Neenah Paper Inc., symbol NP, NYSE, $20.32,
small cap (15,600,000 shares). Neenah was spun off from Kimberley Clark in 2004.
The company produces specialty paper products for filtration, abrasives, wall
coverings, and melt-blown technologies, as well as for packaging and labels.
Earnings are growing at double digits as the company builds on its growing
export sales to Asia and South America. The shares are selling at 11 times
trailing earnings with a dividend yield of 2.1%.
Keep in mind that there are three risks in investing; market
risk (the direction of the overall market), sector risk (the direction of
individual sectors within the overall market), and stock risk (the direction of
individual stocks within a sector).
And there’s more risk in small cap stocks because of their
smaller float of available shares. The smaller float creates bigger gains in
rallies when buying pressure dominates and there are fewer stock-holders willing
to sell, but larger declines if unexpected negative news brings in selling
pressure, since there are fewer bargain hunters aware of the stock and looking
to buy.
One way to substantially decrease individual stock risk is
obviously to diversify among numerous small cap stocks, and the easiest way to
accomplish that is via etf’s designed to track with a small stock index.
So investors interested in the potential for extra dynamism
in small cap stocks might want to consider that route.
Available small cap etf’s include the iShares S&P Small Cap
600 etf, symbol IJR; iShares Russell 2000 Small Cap etf, symbol IWM; and the
Vanguard Small Cap Growth etf, symbol VBK.
Some investors object to investing in an index on the theory
that if they can pick the best performing stocks within the index they can
outperform the index.
Those willing to take the extra risk of individual stocks in
an effort to beat the performance of the underlying index, might want to
consider using a leveraged etf on the index instead. The advantage of
diversification is still achieved, and a two-to-one leveraged etf will double
the performance of the index while still avoiding the risk in the individual
stocks.
One of my favorites in that category is the 2 to 1 leveraged
ProShares Ultra Russell 2000 etf, symbol UWM.
Just be sure to keep in mind that leverage is a two-edged
sword. Leveraged holdings produce gains much faster if you have the direction
right, but also produce losses faster when you’re wrong.
In
the interest of full disclosure, I and my subscribers have positions in one or
more of the holdings mentioned in this column.
Editors: You are welcome to quote from this article, or use it in its entirety, in your publication or on your website, as long as the credit in the above paragraph is also included. Readers are also welcome to e-mail, or print and snail-mail it to friends.
These reports reflect our opinions and are based on our best judgment, but no warranty is given or implied as to their accuracy. Past performance does not guarantee future performance.
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Asset Management Research Corp. -- ALL RIGHTS RESERVED.