Dr. Fariba Ghodsian, chief investment officer of DAFNA Capital, looks for biotech companies that offer a differentiated advantage for a drug – ones that offer a unique product, or a different way to deliver a drug. If the drug is a me-too — i.e. many other companies have a similar drug — then the company is not attractive. She also examines the company’s market potential and its chances for success. “Obviously the market size of the drug is important,” Ghodsian notes. “But sometimes companies can thrive very well in very limited markets.”

She says the market should be an attractive one where the disease is difficult enough that the insurance companies would be willing to pay a high premium. She points to Genzyme (Nasdaq:GENZ) as an example of that. The biotech company made a billion dollar drug out of orphan diseases by tacking on a high price.

It goes without saying that the drug must also demonstrate a favorable safety and efficacy profile to warrant approval, while management is key to get the drug to market.

Ghodsian also examines if the company has the financial resources to go forward. “Often time’s biotech companies raise too little money, or are sometimes shortsighted when it comes to financing and I think that bites them in the end,” she said. “So a company that is well financed particularly in this market is important.”

Most of the companies in Ghodsian’s universe are not profitable. Some of the companies she invests in are very late stage, while some are more in clinical development. Among specific stocks she favors include, Isis Pharmaceuticals (Nasdaq:ISIS), Rigel Pharmaceuticals (Nasdaq:RIGL) and Pozen (Nasdaq:POZN).

Isis Pharmaceuticals is in the business of RNA-based drug discovery and development. Ghodsian finds this to be a unique company because it has a very broad base technology in antisense, which in essence is a way to block genes. “What we really like about Isis is that they have proved that the technology works,” Ghodsian said. “We like the company both for their specific drugs and for their broad technology platform.”

The company has a potential blockbuster drug for the reduction of blood lipids. “It has shown exceptionally strong clinical activity in patients, even those who . . .

Institutional money has been flowing into the biotechnology sector. Both Nasdaq’s and Amex’s biotech indices are up 5.7% year-to-date, while the S&P 500 is down 11.4% year-to-date. According to Prophet.net the industry moved up to a ranking of 14 over the last 6 months, up 27 slots, or 18.05%, from a ranking of 41. Over the last month it’s now ranked eighth overall.

“Biotech has definitely been hurt by the general market, but recently we have seen a strong comeback,” said Dr. Fariba Ghodsian, chief investment officer of DAFNA Capital, which invests exclusively in biotechnology stocks. “Part of it is as the census moved against the market, but part of it is fundamentally.” 

Ghodsian says biotechnology is one of the next hot sectors after we emerge from this downturn. “With different fields in biotech experiencing exciting new developments — from inflammation to cardiovascular to hepatitis C — it clearly offers a lot to improve treatment of diseases and I think it is being recognized in the marketplace,” she said. Ghodsian suspects we may see some of these strides in the companies and therefore the sector this year, but even more so in 2009.

Several recent trends that have characterized the biotechnology space have made Ghodsian very positive on the sector. For one thing, in recent months there have been an unprecedented number of acquisitions across the spectrum by both foreign and U.S. companies, partly because of the weak dollar.

Additionally, large pharmaceutical companies are suffering from very anemic pipelines and their major presence is expiring in the coming years, as patents run out. “Biotech is the natural place for them to look for opportunities to bolster their . . .

Two economic indicators for inflation recently signaled an uptick in nominal terms, as oil has remained at heightened levels. For the month of May on a year-over-year basis, the consumer price index was up 4.2%, while the producer price index jumped 7.2%, marking the eighth consecutive month in which that number was above 6%, which hasn’t happened since 1977 to 1982.

But inflation may not be as negative for small-cap stocks as large-cap stocks.

“[Inflation] is actually pretty good for small caps,” Mary Lisanti, president and chief investment officer of AH Lisanti Capital Growth, said. “Even the 20% inflation we saw in the ’70s was good because their stuff is differentiated enough that they can raise prices.”

Lisanti also points to better control of costs for reasons why small caps wade inflation better than their larger brethren. “These things are working for them now that worked against them for the past four or five years,” she said.

In an interview in March, Lisanti said, “The best of all worlds for small growth stocks is one in which GDP is growing slowly, inflation is modest, and rates are low — such as the early 1990s.”

According to Doug Roberts, author of the book Follow the Fed to Investment Success and chief investment strategist for ChannelCapitalResearch.com, inflation is actually less negative for small-cap stocks in the short-run and positive in the long run.

Roberts uses what he calls the “battleship and PT boat analogy” to explain why the effect of inflation on small caps can be less negative than on large caps. “Even though a PT boat is smaller, if you're trying to shoot it, it has increased speed and can adjust pretty quickly, whereas a battleship, even though it's bigger and has . . .

In an effort to maintain true representation of global equity markets and ensure changes in the market are accurately reflected, Russell annually rebalances all of its indices, including the small-cap Russell 2000 index.

As a result of the reconstitution, the financial and energy sectors are likely to see the most action, according to Steve Wood, senior portfolio strategist for Russell Investments.

“If you’re looking at the market-cap issues, the performance of financials and energy are going to be the two biggest dynamics — energy having done well, financials having done poorly,” Wood said in an interview with SmallCapInvestor.com. “You’re going to see a lot of transition and I think that will account for a significant portion of the migration in and out of [the index]; energy coming to the market cap or moving out of the 2000 whereas financials [will] far further down the ladder.”

Wood says energy will probably graduate to the Russell 1000 from the Russell 2000 (the large cap index), while consumer technology, financials and transportation are the most likely sectors from which companies will be added to the small-cap index.

JP Morgan purports that consumer and financial stocks will comprise 35.81% of the Russell 2000, compared with 34.6% both sectors currently comprise. The investment bank expects 275 additions this year, compared with 175 deletions and forecasts the upper limit for market capitalization will be capped at $165 million. Last year the cut off was $260 million.

Jefferies & Co. estimates that 259 names will be added to the Russell 2000, while 157 names will be subtracted. Of the $4 billion in trade flow that Jefferies expects, the bank says $850 million will stem from materials, while $765 million will flow from technology and $730 million will come from health care.

Certainly the tumultuous state of the economy has been a major determinate . . .

Wyman favors oil and gas companies with an established land position, which he calls “scalable repeatable growth opportunity.” The analyst has “buy” ratings on ProEx Energy Ltd. (TSX:PXE), a natural gas unconventional player; Pearl Exploration and Production Ltd. (TSV:PXX), a heavy oil player; and Sterling Resources (TSV:SLG), an exploration and production company drilling in the U.K. sector of the North Sea and Romania. Wyman said Sterling is a bit riskier, but has an active drilling program.

Votruba is overweight energy in his portfolio, with energy comprising 20% to 25% of the fund manager’s diversified small-cap fund. This compares with the Russell 2000 (NYSE:IWM), for which energy composes 7%.

Among small-cap oil and gas companies, Votruba recommended oil and gas exploration and production company Swift Energy Company (NYSE:SFY). “[It’s] probably one of my favorite picks right now in the E&P. I see it as more of a lower risk play. It’s involved in lower-risk development, and not doing a lot of wild-cat exploration; it’s on their existing properties.” 

Swift Energy has had its obstacles. Investors rebuked the company in the past after management decided to commence operations in New Zealand — a move that boded poorly in retrospect. Management lost credibility with investors as a result, but Votruba thinks the company’s back on track. According to Votruba, Swift Energy has now surpassed both Chevron (NYSE:CVX) and Texaco as the largest oil producer in Louisiana.

However, the company did see production fall in the first quarter on account of production issues. Specifically, Swift began producing new wells that were shut down after pressure issues arose in a handful of the pipelines, which could cause damage to the oil wells.  But Votruba says he’s confident Swift will be able to get its wells operating again in 60 to 90 days, and thinks production will climb 30% in the . . .

“I still think it’s the place to be in the back half of the year,” Jason Votruba, vice president and co-portfolio manager of the UMB Scout Small Cap Fund (UMBHX), told SmallCapInvestor.com. “I’m still very bullish on it.”

The fund manager dismissed the recent pullback in oil, calling it temporary. “If you use technical analysis you can look at the trend channel: we touched the top of the trend and now we’ve pulled back to that of 21-day moving average. I think we could go back to $120 perhaps, if that low, but I think we’re going see higher prices for a while.”

Votruba said that a major factor behind high oil prices for the foreseeable future is scaled-back oil production and burgeoning global demand for tightened supply. Mexico’s production, for example, has slipped 9.1% in the first four months of the year.

“You’ve got a lot of countries that nationalized their oil production; that leads to decreased production and now we’re paying the price,” Votruba said.

In addition to Mexico, Russia and Saudi Arabia have cut back production. China and India are also slurping up oil, as billions of both countries industrialize and new people begin driving automobiles. Government subsidies have also come into play, as gas in the Middle East, for example, goes for a very affordable $1 per gallon.

According to Votruba, there is currently less than 700,000 barrels of spare capacity in the market.

Aside from production, extracting oil takes time. Brazil has recently discovered oil off its coasts; however, there is still realistically five years until those reserves can be tapped. The United States possesses billions in oil as well; however, Congress has banned drilling such reserves.

“There’s plenty of oil out there. That’s not the issue,” Votruba said. “It’s just being able to get to it.”

In a hearing before the Committee on Homeland Security and Governmental Affairs on May 20, Michael Masters, managing member and portfolio manager of . . .

Although investors are usually drawn to the safety of large caps during the worst of economic times (especially within the last two years), sentiment has recently changed now that the bear market looks to be over. Small caps have pulled ahead of their large-cap brethren, up 4.2% in May compared with 1.6% for the Russell 1000, according to the article, titled “In a Rebound, Small-Cap is Beautiful.”

If the past is any indication of the future, it looks like small-cap issues are on the road to recovery as they not only tend to outdo large caps by a decent margin during a market rebound, but their strong endurance usually lasts for several years after, the article said.

According to Ned Davis Research Inc., since 1979 the Russell 2000 (NYSE:IWM) has returned a median 19.6% in the first three months after a market bottom, versus 13.6% for the Russell 1000. After the 2002 bear market ended, for example, small caps dominated for three straight years.

But why exactly do the little guys tend to come out on top after a darker economic period? A myriad of factors come into play, but the article essentially said it's because small caps are usually unglamorous (meaning they are undervalued), their post-downturn profit bouncebacks have a larger impact than at big companies, and they are more nimble and take quicker advantage of a better economy.
 
Steven DeSanctis, small-cap strategist at Merrill Lynch, was quoted as naming companies with international exposure as the best investments when coming out of a downturn. In the first quarter, small caps that possessed this bargaining chip rose 13%, while their competition that played in a more domestic field were down 10%.

Health care was mentioned as a sector with high profit potential, due to its tendency to be mostly unaffected by economic cycles. Small-cap tech plays could also be promising, as DeSanctis said that tech did well in the 1990 to 1991 downturn, but failed to bounce back from the 2000 to 2002 bear market only because the sector was still recuperating from the pop of the late-90s’ bubble. He pointed out that foreign exposure for U.S. tech companies is strong.

Investors should keep in mind that small caps are already getting costlier, the story said, partly because of their recent modest rally; the small-cap index trades at 18 times trailing earnings, while the large-cap benchmark is at 16.5 times. Another caveat could be that if severe inflation returns, DeSanctis said, small caps suffer the most as small companies have fewer resources to deal with increasing costs.

Neverthless, surgical instrument maker Conmed Corp. (Nasdaq:CNMD) was named as a promising small cap in the health-care sector. Half of the company’s revenue comes from international sales, and although restructuring has hurt margins, causing it to trade at a high-end 18 times earnings, Conmed has cut debt and is seeing double-digit revenue growth.

Within the tech sector, The Wall Street Journal named cell phone distributor Brightpoint Inc. (Nasdaq:CELL), whose stock is changing hands at 15 times earnings. "They have a 10% global market share," said Chris Guinther, manager of RidgeWorth Small Cap Growth Fund, in the story.

“It’s happened time and time again throughout history, whether it be the earthquake in China or the flooding in New Orleans or the World Trade center — there is generally a market consequence,” Jim Trippon, editor in chief of the China Stock Digest newsletter, said in an interview with SmallCapInvestor.com. Trippon runs the largest equity investment research firm in mainland China and advises corporate pensions, private trusts, and high-net-worth families on their China investment strategies. “Anytime that happens, at least for the short term, there’s a pull back in all stocks, which generally creates a tremendous buying opportunity if you can differentiate between the winners and the losers.”

Even though the earthquake has shaken the Sichuan Province, the region only comprises 4% of China’s GDP, meaning there is marginal downside from a macroeconomic standpoint.

As China rebuilds, commodities, companies that produce commodities and companies who are in some fashion tied to commodities will be a lucrative space for investors to park their cash on account of this earthquake. China’s torrid growth of 10% on average has been a major source behind the skyrocketing commodity prices as the country has sought to build infrastructure. The recent earthquake magnifies that effect. Any building materials — oil, steel, timber, aluminum, copper and cement — needed to reconstruct China will benefit. 

“What’s happening right now with the earthquake is that we’re seeing demand continue to go up because they’re rebuilding,” Trippon said. “What that means for us as investors is we can realistically expect further increases in commodity prices across the board.”

The drybulk shipping space is one that will benefit from the earthquake and . . .

“There are a number of factors that have led me to believe that small-cap equities will probably do well going forward — and those factors center on how bad things are right now,” Greiner said in an interview with SmallCapInvestor.com.

Greiner points to economic indicators for signs of probable future success for small caps. First he examines consumer sentiment. According to the veteran investor, when you analyze the consumer sentiment data, you look at the trend over the last 30-year period. When the read on consumer sentiment has been below a level of 96, the following 12-month period of time small-cap companies have outperformed large cap companies by close to 1,000 basis points, Greiner said. The latest read on the consumer confidence index was below 76.

“When the consumer’s been this negative before, it’s been a great time to buy small-cap companies,” he said.

Next, Greiner looks at economic coincident indicators, a coincident economic indicator is one that moves at the same time the economy does. The latest read for coincident economic indicators overall was 0.56%. 

“The last time we were in this environment was back in the early 2000’s, right before the start of the big rally in stocks in general,” said Greiner. “That leads me to believe that small-cap companies are probably positioned relatively well.” 

According to Greiner, when coincident indicators have been at this stage historically, small-cap stocks on average generated returns of 25.6% for the next 12-month . . .