Small-cap investing is about owning businesses that have the potential to be 10- or even 100-baggers. The best small-caps are the ones that minimize the risk but have potential massive upside.
We boil down small-cap investing into Six Laws that are supported by academic studies, logic, and history. The goal of The Six Small-Cap Laws is to quantify the top small-cap stocks in the market today, the ones that limit the downside and offer vast opportunities for outperformance. These stocks are usually choices of top hedge fund managers who we profile in our quarterly issues.
Each law is listed below:
Law #1: Outperformance
Law #2: Underfollowed
Law #3: Investor Exclusion
Law #4: Be wary of who you listen to
Law #5: There are no shortcuts
Law #6: Find your ambassador
Laws 1 to 3: Why small-caps are the best investments in the stock market
Law # 1 – Outperformance
Small-caps have historically outperformed their larger-cap counterparts. Ibbotson Associates shows that small caps increased in value by an average of more than 12% per year between 1927 and 2007. Meanwhile, large caps have increased just over 10% during that same time period. If you invested $1,000 in large caps in 1925, today you would have $3 million, versus the $16 million if you’d invested in small-caps.
One of the beauties of small-cap stocks is that you can get in on the ground level. Small companies inherently have the ability to grow faster than larger companies – it’s much easier for a $500 million to double than it is for a $25 billion company.
Law # 2 – Underfollowed
Small-caps aren’t well followed or well-researched. Wall Street doesn’t cover the small-cap stock space as heavily as it does larger-cap stocks. That’s because there isn’t enough money in covering and reporting on small-caps, so research firms and Wall Street banks avoid the stocks.
What this does is create opportunities when it comes to mispricings. Given the fact that there’s little coverage of small-caps, stocks in this part of the market can be undiscovered or misunderstood, creating large discrepancies between the stock prices and the actual value of the companies.
Law # 3 – Investor Exclusion
Small-caps aren’t just shunned by the media and analysts, but also by the big investors like mutual funds. Many mutual funds can’t invest in small-caps because of the small market cap, where mutual funds can’t buy a large enough stake in the small-cap to make a difference in the fund. With that, individual investors have the advantage, as they can spot and invest in promising small-caps that institutional investors cannot.
Laws 4 to 6: How to find the best small-caps
Law # 4 – Be wary of who you listen to
Many billionaires have no clue what they’re doing when it comes to small-cap stocks. And for the most part, these small-caps only make up a small portion of their portfolio. So following billionaires and looking through 13Fs to figure out what large investors are doing in the small-cap space can be a fool’s game.
Law # 5 – There are no shortcuts
You can’t pick small-caps with an algorithm or fancy strategy, it takes hard work. There are vastly more small-cap stocks than large-caps. Thus, sorting through the small-cap universe is time-consuming. Then you have the time to actually do serious research, where there’s a lack of readily-available info, such as research reports. Plus, you’re going to want to do some extra due diligence since many small-caps
We don’t chase stock tips or have a supercomputer. What we do have is access and work ethic. What we do is find underrated hedge funds beating the market by investing in underfollowed small-cap stocks. We then bring their knowledge and insight on investing in small-caps, along with deep dives into the hedge fund’s top small-cap picks, to The Underrated Small-Cap Stocks newsletter subscribers.
Law # 6 – Find your ambassador
Although we’ll be the first to admit that falling large hedge funds can get crowded, we have found immense value in following the underrated hedge funds that have had success in finding small-cap stocks that outperform.
We let hedge funds do the hard work for us. There are a number of underrated hedge funds out there outperforming the market, but since they don’t have to report their holdings publicly, they aren’t covered by CNBC or other newsletters.
The media would have you believe that small-caps are volatile and too risky, but we’re not talking about penny stocks. We only profile small- and micro-caps that have plenty of liquidity and have been vetted by hedge fund managers we know and follow.
Small-Cap Laws: Real Life Example
Instead of telling you what Carl Icahn is buying, we’re here to tell you about the “unknown” hedge funds, such as Raging Capital, which has generated an annualized return of 22% since inception in 2006. Compare that to the meager 7% annualized return the S&P 500 has generated over the same period. This is just one example of underrated hedge funds that we’re interviewing.
Put The Six Small-Cap Laws To Use
The first step is to actually use The Six Small-Cap Laws. We’ve made that as easy as possible with the Underrated Small-Cap Stocks newsletter.
The Underrated Small-Cap Stocks newsletter features an underrated hedge fund manager with an issue every other month. In it, we profile the manager’s process for finding ideas, where they’re finding value in the market today and much more. We also do a deep dive into the underrated hedge fund’s top two small-cap stock picks. We also give you updates from the manager on new picks, performance and more on a quarterly or monthly basis (depending on the fund)
Our goal is to help you find the very best small-cap stocks that are poised to outperform.
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