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Small Cap Investing

Written By Brian Hicks

Posted November 5, 2007

Publisher’s Note:

It’s my honor and pleasure to introduce you to Ian Cooper. I worked with Ian several years ago when we were both investment analysts for the advisory service, Taipan.

Ian has decided to join Wealth Daily as our small cap and trading expert. He is a superstar technical analyst, initiating 950 winning trades in this decade alone. His win-to-loss ratio is an astonishing 72%… in other words, out of 10 trades he initiates, 7.2 result in profits.

Please join me in welcoming Ian to the Wealth Daily team.

Small Cap Investing: Warren Buffett’s Greatest Disadvantage
By Ian Coooper

What if I said I could suggest a way to turn a sizeable profit?

Scratch that.

What if I told you that I know I could? Better yet, I’ll do it using nothing more than publicly traded stocks that any retail buyer can pick up.

But there’s a catch.

That, my friends, is one of the boldest claims made by billionaire, Warren Buffett.  But like I said, there’s just one catch. 

It can’t be done buying Coca-Cola, American Express, or even Berkshire Hathaway.

Instead, you have to back up the truck on lightly followed small cap stocks – the very ones where retail investors have the advantage over institutions. 

You don’t have a problem with that, do you?  Unfortunately, Buffett does, proving it’s not always good to be a multi-billionaire on Wall Street.

I know, perish the thought.

He may be the world’s second richest man next to Bill Gates.  Everything he’s touched turned to gold – Coca Cola, Berkshire Hathaway, GEICO, Gillette, The Washington Post, and American Express.  He’s regarded as godlike by Wall Street with the power to move markets with his words.

But his billions are keeping him from buying the very stocks he wants to buy.  Honestly.

And if you don’t believe me, here’s what he had to say in 1999.

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.”

“The universe I can’t play in [small caps] has become more attractive than the universe I can play in [large caps]. I have to look for elephants. It may be that the elephants are not as attractive as the mosquitoes. But that is the universe I must live in.”

Here’s what he had to say in 2005.

The best decade was the 1950s; I was earning 50% plus returns with small amounts of capital. I could do the same thing today with smaller amounts. It would perhaps even be easier to make that much money in today’s environment because information is easier to access.”

What does that mean?  It means Buffett may be a little jealous… well, just a little.  He’s the second richest person in America with the knowledge that mosquitoes are still producing 50% a year, as compared to large caps today.


He’s painfully aware that from 1925 through 2005, small cap stocks returned annual 12.6% returns, as compared to annual returns of 10.4% for large cap stocks. 

Truth is, exposure to small cap stocks is a necessity if you want to build a strong portfolio and accumulate lasting wealth. Even Buffett will tell you that after seeing how small cap stocks have performed from 2003 to present day.

Small Cap Investing: Russell 2000 Chart

Small Caps: For the Radar Screens

I want you to keep an eye on the Russell 2000, the most widely-followed small cap index.  On Friday, we got a tepid bounce on jobs, which gave us two divergent patterns.  There’s the head and shoulders top, and a double bottom on Friday lows.  Should 787 hold strong support, we’ll get a possible leg up.  On a bounce off the double bottom, we want to watch for a break above 815. 

It just proves that uncertainty lives on in a tough economic climate.  That doesn’t mean small cap opportunities aren’t abound.  Here are two.

Despite a YTD 125% move, Elixir Gaming (EGT) remains a relative unknown with exposure to the explosive Asian gaming markets.  It’s now trading just below multi-year highs after announcing agreements for another 700 electronic machines. 

What’s impressive is its exposure to Las Vegas and the growing popularity of Macau.  While it’s not yet profitable, buying now is the smart play.  And here’s what I mean: there are only two analysts covering this Asian gem.

This baby is well below Wall Street’s radar.

EGT is still a small and highly speculative name with a $162.3 million market cap and a float of 18.2 million shares.  We’re looking for additional investor interest once it shows up on the 52-week high lists again.

Just to give you some background on Asian gaming growth, take a look at Macau at the tail end of 2006.

In less than a year, Macau saw visitor growth soar by some 12% thanks in part to a raft of casino openings in the region. And it’s only expected to skyrocket even more as casino developers rain down on a region where 1.3 billion people live within a three-hour flight of Macau, and another 100 million people are within a radius of a three-hour drive, according to Macau Business News.

What does that mean for investors? Buy any company that’ll be involved in Macau casino growth.

What else would you like?

How about the fast-exploding $900 million social networking market!

There’s explosive growth appeal for Facebook, which will IPO one day along with LinkedIn and Classmates.  U.S. visitors to Facebook have doubled inside a year to 33.7 million, as MySpace visitors grew 23% to 68.4 million.

But are there undervalued, under-the-radar-gems that already exist for small cap investors?  Yes and yes.

Israel’s IncrediMail (MAIL) allows users to add thousands of e-mail backgrounds, Emoticons, Ecards, sounds, animations and 3D effects to e-mail.  It’s fun for the younger generations who are flooding the social networking scene.

But here’s why investors should pay attention.

IncrediMail Ltd. (MAIL) has been flying under the radar since early 2006, all the while posting impressive growth and profitability.  Numbers prove it’s just beginning to scratch the surface of long-term profitability.

Q2 2007 revenue increased 111% to $4.3 million.  Six month revenue soared 106% to $8.7 million.  And net was up 59% to $600,000, thanks in part to advertising revenues, which just hit $1.9 million and growing.  Insiders are loading up.  There’s no debt, and $28.7 million in cash on hand.  And there’s a severe shortage of analyst coverage. 

For a profitable company to be growing its bottom line that fast, this is a steal.  And it doesn’t hurt that other Internet companies have shown real interest, including (from what I’ve heard), Facebook. 

These are just a couple opportunities that can be found in the small cap land. And in the coming weeks, I’ll bring you even more.

Ian L. Cooper