The Small-Cap Investor
Secrets to Winning Big with Small Cap Stocks
by Ian Wyatt
Ian has discovered over the years that small-cap
stocks can provide the best long-term returns for investors. Small-caps are
the one area where individual investors can truly have a leg up on Wall
Street, due to the lack of analyst coverage and institutional ownership.
I can understand when investors are bearish on the stock market and the U.S. economy. After all, there are always two sides to the coin, forget about all the ridges along the outer perimeter. Official unemployment is near 10%. The housing market is only gradually improving, and there's record government debt here in the U.S. and in many other countries.
But the bears need to take another look before they add high stock valuations to the laundry list of downside catalysts. Because the numbers say stocks are as cheap as they've been since 1990. I think the market needs to pull back a bit in order to hold onto the gains it has made in 2010 - but ultimately I believe many stocks should be trading higher than they currently are.
Sure, it's easy to look at the 80% move by the S&P 500 and think stocks must be expensive. Same goes for the Russell 2000 which has moved over 100% higher since the March 2009 lows.
But so far, 1st Quarter earnings have beaten analysts estimates by an average of 22% (according to Bloomberg) and 80% of reporting companies have beaten expectations.
Analysts have raised forward earnings estimates for S&P 500 companies by 9.3% in April. The index has responded with a 3% move in April.
Analysts say that S&P 500 companies will earn $85.96 a share in 2011. The record for per share earnings is $89.93, set in 2007. The S&P 500 was 20% higher then. The current P/E for the S&P 500 is 14.
What is really interesting is that I’m seeing a lot of analysts raising earnings estimates, but not increasing their ratings on stocks. This is especially true for small cap stocks. Bloomberg points out that only 30% of U.S. stocks have a "buy" rating. It seems rational to assume the rest are "holds" or "sells."
When analysts change their rating on a stock, it's usually headline news. But when estimates change, there's usually not much fanfare. In fact, you might not even know unless you go to a website like Yahoo! Finance and look for yourself at the latest analyst earnings expectations.
I expect this is why some investors are still skeptical of the stock market’s rally - and are hesitant to put new capital to work at these levels.
***The reality is that corporate earnings will grow until they don't. And once analysts start estimating flat growth (or horror of all horrors, decreasing growth) there is usually a nasty correction.
But there are usually signs when this starts to happen. But so far, no analysts are coming out and questioning whether earnings estimates are too high. In fact, it's pretty clear that corporate earning power continues to surprise analysts. And they continue to play catch up.
It's unlikely that earnings will all of a sudden reverse course anyway. We should at least see a quarter or two where earnings are pretty much in line with expectations. Until that happens, a bullish bias towards stocks is appropriate.
***This weekend marks one of the biggest investor events of the year – Warren Buffet’s annual shareholder meeting for Berkshire Hathaway (NYSE: BRK-A). There could be as many as 50,000 people in Omaha, Nebraska looking to glean investment advice from Buffet and Vice Chairman Charlie Munger.
I recently put together a special report that includes three stocks that Buffet would love to buy. These companies have strong corporate culture, great leadership, and good cash flow. And one of them has a market cap of only $780 million.
Buffett can’t invest in this stock because it’s too small. But you can, and I’d like to give you the opportunity to find out more about it. Between today and May 1, I’m giving subscribers to Small Cap Investor Daily an opportunity to get my Special Report: The Warren Buffett Retirement Planfor free when they sign up for a subscription to Top Stock Insights. This advisory service covers stocks across the full spectrum of market caps - and there is one small cap in particular that I think you’ll find compelling.
Savvy investors already know that Warren Buffett is the greatest living investor. But it's tough to match his gains unless you buy stocks BEFORE he does.
This weekend marks one of the biggest investor events of the year - Warren Buffet's annual shareholder meeting for Berkshire Hathaway (NYSE: BRK-A). There could be as many as 50,000 people in Omaha, Nebraska looking to glean investment advice from Buffet and Vice Chairman Charlie Munger.
But you won't hear Buffett talk about small cap stocks. The investing icon is more likely to discuss the future of derivatives and how potential changes in collateral requirements for derivatives could impact Berkshire in the future.
In fact, small cap stocks are essentially off limits for investors with the massive sums of money that Buffett manages because the reality is it would be easier for him to simply buy the company. He invests billions of dollars at a time. But that doesn't mean he doesn't see huge potential in smaller companies. In fact, he has been quoted as saying that he could virtually guarantee outperformance if he could invest in this asset class. The most oft quoted statement came from a 1999 Business Weekarticle:
"If I was running $1 million today, or $10 million for that matter, I'd be fully invested. Anyone who says that size does not hurt investment performance is selling. The highest rates of return I've ever achieved were in the 1950s. I killed the Dow. You ought to see the numbers. But I was investing peanuts then. It's a huge structural advantage not to have a lot of money. I think I could make you 50% a year on $1 million. No, I know I could. I guarantee that."
Now fortunately, most of us don't have the same issue as Warren Buffett. We aren't hampered by the weight of having millions of dollars we need to invest. What a drag that must be!
But seriously, he has a point and has discussed exactly what he meant by this statement several times. It comes down to finding small opportunities and booking quick gains before everybody else sees the same opportunity.
That's exactly what small cap investing is all about.
I recently put together a special report that includes three stocks that Buffet would love to buy. These companies have strong corporate culture, great leadership, and good cash flow. And one of them has a market cap of only $780 million.
Buffett can't invest in this stock because it's too small. But you can, and I'd like to give you the opportunity to find out more about it. Between today and May 1, I'm giving subscribers to Small Cap Investor Daily an opportunity to get my Special Report: The Warren Buffett Retirement Planfor free when they sign up for a subscription to Top Stock Insights. This advisory service covers stocks across the full spectrum of market caps – and there is one small cap in particular that I think you'll find compelling.
The company was founded in 1905, and it hasn't changed much since then. It makes many of the same products and reward shareholders with steady profits.
If that's not enough, this company also pays a $1 dividend. That means for every 1,000 shares you own, you get $1,000 every year.
It manufactures goods in three sectors: house wares and small appliances, defense products, and absorbent products. It's not the most exciting company out there, but it's exactly the type of company you can invest in and enjoy both capital gains and that dividend yield. It's exactly the right kind of stock for a retirement account.
Savvy investors already know that Warren Buffett is the greatest living investor. But it's tough to match his gains unless you buy stocks BEFORE he does.
Put financial services and insurance together in a sentence and most people think of some of the nation's largest companies in the industry: Berkshire Hathaway Inc. (NYSE: BRKA), American International Group, Inc. (NYSE: AIG), MetLife Inc. (NYSE: MET), Allstate Corp. (NYSE: ALL) and The Hartford Financial Services Group, Inc. (NYSE: HIG). But one ever-growing small-cap is poised to make a name for itself.
Meet American Physicians Service Group, Inc. (Nasdaq: AMPH), an Austin, Texas-based $130 million company that not only provides brokerage and asset management services to individuals and institutions, but also provides insurance services including medical malpractice insurance. The insurance services segment provides financial management service to banks and insurance companies that provide liability insurance to doctors, while its financial services segment provides brokerage, asset management and investment advisory services to individuals and institutions.
Though the company has been around since 1974, American Physicians Service Group is not exactly a household name. But with a strong second quarter under its belt and glowing future prospects, that is bound to change. The company owes much of its recent success to smart management. The ambitious firm is expanding from its rather modest local roots thanks largely to a savvy acquisition. In April 2007, the company completed its acquisition of American Physicians Insurance Company (API), a firm whose operations it had managed since the mid-1970s.
In the quarter ended June 30, APS increased both revenue and earnings, reporting a net income of $12 million, or $2.37 a share, compared with $598,000, or $0.21 a share, in the same quarter last year. Revenues more than tripled to $29 million, compared with $8 million over the same period in 2006. In addition, the company posted a gain of $2.3 million related to the API merger. 2007 EPS projections of $3.38 are more than 300% higher than 2006 results.
"This is our first quarter to report combined results with API . . . and those results have exceeded our expectations. Due to continued positive claims trends, we lowered claims reserves and related reinsurance reserves by $14.1 million in aggregate this quarter. However, we remain very conservatively reserved at the upper end of the actuarial range," Chairman Ken Shifrin said in a statement. "In addition to favorable development in reserves, our policyholder count continues to increase. During the twelve months ended June 30, 2007, our total policyholder count increased by 462 to 4,802. This is largely due to our favorable 90% retention rate in 2007. Though the market continues to be characterized by rate pressure, our profit margin remains strong due to continued favorable trends in the frequency of claims.”
Shifrin also said that American Physicians financial services segment has performed very well, with revenues up 46% for the first six months of 2007, compared with the same period last year, and pretax profits up an impressive 68% in that same time frame.
Wall Street has taken notice. On July 6, Steven D. Schwartz, an analyst at Robert W Baird, initiated coverage of American Physicians with a "strong buy" rating and a target price of $22.50. Analyst John D. Gwynn at Morgan Keegan followed suit on July 18, with a new "outperform" rating. On Aug. 27, ValuEngine.com, a stock valuation and investment forecasting service, also upgraded the stock to a "5" rating, the service's highest—only 85 of the 5,000 companies they cover have achieved the rating.
After gobbling up API, American Physicians quickly set about extending the brand. The windfall profit from the acquisition, along with a June 20 secondary public offering of stock, is already allowing American Physicians to grow its insurance presence beyond the Lonestar State.
On Aug. 22, company executives announced expansion into Oklahoma's medical malpractice insurance market. The API subsidiary was granted a Certificate of Authority by the Oklahoma Insurance Department to write doctor's professional liability insurance (to protect against lawsuits alleging medical mistakes). With a new CFO scheduled to take the helm on Nov. 16, the company is gearing up to grab some market share from Physicians Liability Insurance Co. (PLICO), a homegrown insurer which controls 80% of the medical malpractice insurance market in the state.
President Tim LaFrey commented on the occasion: "Gaining access to the Oklahoma market is another step in our growth plan. Since our acquisition of API in April, we progressed in our strategic plan by raising approximately $36 million and contributing $10 million of additional surplus to API. That new surplus gives API additional underwriting capacity for initiatives such as this expansion and better positions us to receive a favorable financial strength designation from an insurance rating agency."
Senior VP Maury Magids added, "We are excited to be partnering with Oklahoma physicians. Having the ability to write business in Oklahoma allows our company to extend coverage to existing insureds that are now expanding into Oklahoma. But most importantly, it gives Oklahoma physicians a carrier to consider for their medical malpractice coverage that is supported by a high degree of service, value and integrity. Oklahoma physicians will now be able to experience the commitment API makes to building relationships and protecting its insureds."
On Wednesday, American Physicians’ shares closed at $18.35. The 52-week high is $20.00; the low is $14.37. Analysts who track the stock have a consensus one-year target estimate of $22.50.
Wyatt Research was founded in 2001 as an investment research focused publisher of information for active individual investors. The company offers independent research and analysis of the financial markets, stocks, bonds, ETFs, and mutual funds to +250,000 individual investors through a variety of investment newsletters, trading alert services, and e-letters.
