My wife is terrified of lizards.
There’s no reasoning with her phobia. Even the most harmless of geckos and salamanders send her fleeing in terror.
And so it was that over the weekend, she edged fearfully into my basement office to report a little green fellow who’d wandered in a door left open to the pleasant fall weather.
She wanted me to catch him. If you’ve ever tried this, you’ll know how difficult it is.
First you must find your target … who’s evolved specifically to avoid big blundering mammals like us.
Then you must figure out how to trap it. I ended up moving furniture away from one corner and herding it there, finally sweeping it into a little cardboard box.
The whole ordeal was difficult and time-consuming … just like finding certain types of stocks.
I’m not talking about the stocks that dominate the headlines.
I’m talking about the 80% of listed U.S. companies that most investors have never heard of because they’re so small.
Finding the winners in that lot is every bit as difficult as trapping that blasted lizard … and a lot more profitable.
Small Bets, Big Wins
If you had invested $10,000 in energy drink maker Monster Beverage (Nasdaq: MNST) when it IPOd in 1995, you’d now have more than $21 million.
That’s a total return of 212,468% — second only to Amazon over the same period.
Or you could have made a 45,750% gain on Tractor Supply Co. (Nasdaq: TSCO) by buying it on launch in 1994.
The problem is, you couldn’t have known then what we know now.
So how did the investors who made those big returns do it? How did they know where to place their bets?
By doing their homework.
Size Does Matter
When they first listed, Monster Beverage and Tractor Supply were tiny companies. Most investors probably didn’t know they existed.
But some did. And they made big gains.
Small and microcap stocks are far out on the risk/reward spectrum.
Unlike time-tested large-cap stocks, whose share price generally grows along with their revenues, small-cap companies are extremely risky.
The likelihood of outright failure is high.
But so are the potential rewards.
Let’s say you invested $10,000 in each of 10 startups from 1994 to 1995. Let’s say MNST and TSCO were two of them. The other eight were flops.
You lost $80,000 on those eight. But you made millions on the other two.
Small-cap investing is a bit like horse racing.
Experienced punters know that big gains come from spreading your bets across the favorites and relative unknowns. Given the odds, if one of the unknowns hits, a small bet can turn into a huge win.
Your Small-Cap Cheat Sheet
The potential for market-beating returns from small and microcap companies is always there. But it’s an especially attractive bet when the market is battling headwinds. That has certainly been the case this year, with fears of inflation, a resurgence of COVID-19 and governance failure in Washington D.C.
But look how small (RED) and microcap (ORANGE) stocks have done over the last 12 months. They’ve outperformed everything else, including the mega-cap tech stocks:
(Click here to view larger image.)
But those outsized gains come from a handful of spectacularly successful companies that have lifted up the entire index.
So, how would you know where to find them?
The most successful horse racing bettors use a cheat sheet. It’s a concise publication that lists the top prospects amongst all the horses running on a particular day. It’s based on careful research compiled by experts. It improves your odds dramatically, by giving you access to insights that other punters don’t have.
If you’re going to play the risky game of investing in small caps and startups, you need your own cheat sheet.
Editor, The Bauman Letter