{"id":37567,"date":"2013-04-15T15:24:31","date_gmt":"2013-04-15T19:24:31","guid":{"rendered":"http:\/\/countingpips.com\/forex-news\/?p=37567"},"modified":"2013-04-15T15:24:32","modified_gmt":"2013-04-15T19:24:32","slug":"book-review-the-little-book-of-big-profits-from-small-stocks","status":"publish","type":"post","link":"https:\/\/www.investmacro.com\/forex-news\/2013\/04\/15\/book-review-the-little-book-of-big-profits-from-small-stocks\/","title":{"rendered":"Book Review: The Little Book of Big Profits from Small Stocks"},"content":{"rendered":"

By The Sizemore Letter<\/u><\/a> <\/p>\n

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\nThe \u201cLittle Books\u201d series has produced several memorable titles, such as Joel Greenblatt\u2019s The Little Book that Beats the Market<\/i>.\u00a0 Greenblatt offers a mechanical investing strategy that involves very little work on the part of the reader.\u00a0 You simply build a portfolio of 30 stocks from his screener and re-run his \u201cMagic Formula\u201d screen on an annual basis.<\/p>\n

Hilary Kramer’s Big Profits from Small Stocks<\/i><\/a><\/strong> is not that kind of book.\u00a0 Kramer does not offer a trading strategy or a proprietary screener.\u00a0 Instead, she teaches her readers how to think for themselves.<\/p>\n

Kramer, herself a Wall Street veteran, has carved a niche for herself in an area where most professional money managers are afraid to tread: low-priced stocks trading for less than $10 per share.<\/p>\n

As Kramer points out, most mutual fund managers and other institutional investors could not buy low-priced stocks like these even if they wanted to; their investment mandates forbid it.\u00a0 But even if they have the ability, few have the intestinal fortitude.\u00a0 Their own research departments generally won\u2019t cover the stocks, and it\u2019s a career risk to buy a stock that is too far out of the mainstream.\u00a0 As the old saying goes, \u201cno one ever got fired for buying IBM.\u201d\u00a0 But if a manager bets big on a smaller company that ends up going bust, they might be out of a job.<\/p>\n

Not all low-priced stocks are good buys, of course.\u00a0 As Kramer writes, \u201cMany stocks under $10 are cheap because they deserve to be.\u00a0 They are dogs that never had potential, were permanently damaged by the recession, of have misstepped so badly they have no hope of ever getting back on track.\u201d<\/p>\n

Still, there are potential gems for those investors willing to do the research and look.\u00a0 It is here that you\u2019re most likely to find a \u201cbreak out\u201d stock.\u00a0 Due to the mechanics of the market, it\u2019s generally a lot easier for a $5 stock to go to $10 than for a $50 to go to $100.\u00a0 Yes, the percentages are the same.\u00a0 But lower-priced stocks tend to be low-capitalization stocks as well.\u00a0 A large institutional investor like a Warren Buffett moving into a small cap stock is going to move the price a lot more that he would in a large, liquid stock with an enormous float.\u00a0 The key is finding these gems before the big boys do.<\/p>\n

Kramer notes that low-priced stocks are a great place to find fallen angels, or large (formerly) blue chip companies that have fallen out of favor for various reasons, such as missing an overly optimistic earnings forecast or lack of direction from management.\u00a0 In looking for a fallen angel, you have to ask two questions: What went wrong? And can it be fixed?<\/p>\n

Kramer gives the example of Ford, a stock that she bought during the pits of the 2008-2009 crisis.\u00a0 It\u2019s pretty easy to see what went wrong with Ford.\u00a0 Their product line had gotten stale, they owned too many non-core brands, they had too much debt, and they had obligations to the United Auto Workers they could never hope to honor.\u00a0 But could these be fixed?\u00a0 Well, at least in the short-term, yes.\u00a0 Ford revamped its lineup, sold off some of its non-core brands, and restructured some of its debts and union obligations.\u00a0 Oh, and in the process, Kramer\u2019s investment soared from $2 per share to $18 two years later.<\/p>\n

You cannot do a screen for fallen angels and buy them as a group.\u00a0 You really have to examine each on a case-by-case basis and make a judgment call.\u00a0 There are, alas, no short cuts!<\/p>\n

All large companies start small, and low-priced stocks are often a good place to find up-and-coming growth stocks. Often times, these are going to be companies in non-sexy industries, such as junkyards or waste collection.\u00a0 Though Warren Buffett usually buys larger companies, some of his outsized returns over the years have been due to his willingness to buy companies in \u201cboring,\u201d unglamorous industries.<\/p>\n

Finally, low-priced stocks are a great place to find companies in the \u201cgood old bargain bin,\u201d or companies selling for less than their book value.<\/p>\n

Kramer identifies two sectors in particular that tend to be good hunting grounds for low-priced stocks.\u00a0 The first is one that I would advise caution in exploring: medical and biotech stocks.\u00a0 Biotech stocks often have \u201cbinary\u201d outcomes.\u00a0 They produce a new \u201cit\u201d drug and enjoy returns of hundreds or thousands of percent or they don\u2019t, and they end up going bust.\u00a0 Still, if medical technology is an area of expertise for you, it might be worth your while to give these stocks some attention.<\/p>\n

Kramer\u2019s other hunting ground is one that I am a fan of myself\u2014emerging markets.\u00a0\u00a0 With Europe, Japan and the United States all mired in long-term debt and demographic problems, emerging markets will be some of the few reliable sources of growth in the years ahead.<\/p>\n

But here too, you need to be careful.\u00a0 What makes these stocks potentially attractive is that they are not widely covered by Wall Street.\u00a0 But part of the reason they are not covered is that they don\u2019t have much in the way of public reporting, and what they do have may or may not be in English.<\/p>\n

Plus, you might have a hard time buying them.\u00a0 Many do not trade in the U.S., or if they do it is on the \u201cover the counter\u201d markets, which tend to be thinly traded.\u00a0 So, you\u2019ll need a broker that will give access to foreign exchanges.<\/p>\n

A low-priced investment strategy is a value approach of sorts, but it is different from the sort of value approach that many investors are used to taking.\u00a0 For example, Kramer maintains that the price\/earnings (P\/E) ratio, which is a basic metric known to all value investors, is generally not applicable to the low-priced stocks she covers:<\/p>\n

\u201cWe are looking for signs of improvement and plans to continue or return to a growth trajectory.\u00a0 For example, the P\/E ratio isn\u2019t going to help us pick these kinds of stocks.\u00a0 After all, the P\/E ratio requires the current share price and the earnings per share price for a stock.\u00a0 And often low-priced stocks have little to no earnings at the time they are poised to become breakout stocks, or show earnings that are cyclically depressed\u201d<\/i><\/p>\n

As a case in point, Ford had P\/E ratio of 88 when Kramer bought it because its earnings had been gutted in the crisis.\u00a0 You don\u2019t really care what the earnings were yesterday; you want to estimate what they will\u00a0 be tomorrow.<\/p>\n

There is a lot of investing wisdom in the pages of Big Profits from Small Stocks<\/i>, and Kramer has chosen her hunting grounds well.\u00a0 I don\u2019t always pay attention to academic work in finance because a lot of it is nothing more than a very sophisticated way of stating the obvious.\u00a0 But there was one 1992 landmark paper by Eugene Fama and Kenneth French titled \u201cThe Cross Section of Expected Stock Returns\u201d that basically proved that value investing and small-cap investing outperform over time.\u00a0 Kramer\u2019s low-priced stock approach is really a small-cap value strategy.<\/p>\n

In any event, Kramer\u2019s approach will work best during or immediately following a crisis, when the market is full of fallen angels that were the proverbial baby thrown out with the bath water.\u00a0 During times of relative market calm\u2014such as today\u2014there are simply going to be fewer opportunities and the ones that are out there will require more research to find.<\/p>\n

I recommend you keep Kramer\u2019s book on your shelf and give it a read next time we get a good market sell-off.<\/p>\n

SUBSCRIBE\u00a0<\/a><\/strong>to\u00a0Sizemore Insights<\/em>\u00a0via e-mail today.<\/p>\n

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