Big Profits in Microcaps that Measure Up

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By Josh Levine
Editor,
MicroCap Investor

It's like the old vaudeville routine: You can call them “microcaps,” or you can call them small caps,” or you can call them "penny stocks." For purposes of my MicroCap Investor advisory service, “microcaps” are the best representation of the stocks I recommend.

Many folks in the business use small cap as a euphemism for stocks that are in fact microcaps. The term penny stocks, however, is most often applied to OTC and Pink Sheets stocks that sell at, you guessed it, below $1. Yet in some cases I've seen penny stocks used for stocks selling under $5 and even $10. Go figure.

By my definition microcaps are stocks with market capitalizations up to $300 million, though some analysts cap it at $250 million or even $200 million. Along with this number, I also consider a stock's liquidity, Wall Street analyst coverage, and institutional ownership as useful data for sizing up microcaps.

Fallen Small Caps

Market conditions continue to favor the larger, more fully formed microcaps. This has led me to look more closely at stocks that have fallen from the small-cap tier (i.e. above $300 million market cap) and into the microcap universe.

Three stocks I've followed over the years that are currently on my watch list as prospective targets are:

  • Echelon Corp. (ELON) -- Develops and markets an open standard, multi-application energy control networking platform. Its technology platform, embedded in more than 100 million devices, 35 million homes, and 300,000 buildings, powers energy-savings applications. Market cap: $180 million.
  •  Rubicon Technology (RBCN) -- Develops, manufactures and sells monocrystalline sapphire and other crystalline products for light-emitting diodes (LEDs), radio frequency integrated circuits (RFICs), blue laser diodes, optoelectronics and other optical applications. Market cap: $210 million.
  • Sangamo BioSciences (SGMO) -- Develops novel DNA-binding proteins that can control gene expression, and consequently, cell function. It has ongoing Phase 1 and Phase 1/2 clinical trials to evaluate the safety and efficacy of a novel therapeutic for the treatment of HIV/AIDS, as well as therapeutic programs focused on several diseases. Market cap: $220 million.

These three microcaps are great examples of the opportunities that fall into our target universe. Though each essentially has all of the characteristics of a small cap company, by the most important measure (i.e. market value) they are technically microcaps and in my sights.

The Muppet Show

Only a few weeks ago, Wall Street's puppet masters were screaming that investors (read: “Muppets”) have a generational opportunity to invest in stocks. Goldman Sachs issued a decree calling this the best possible time to move out of bonds and to dive into equities. Here is the report's conclusion:

“Given current valuations, we think it's time to say a 'long good bye' to bonds, and embrace the 'long good buy' for equities as we expect them to embark on an upward trend over the next few years.”

A similar “raging bull” message was delivered by Larry Fink, who heads BlackRock, the largest money-management firm in the world. Money manager Barton Biggs also chimed in with an allocation for 90% long.

As Zero Hedge articulates, “anchors on comedy-financial fusion channels are channeling the producer in their earpiece and screaming at the teleprompter to 'sell bonds and buy stocks'.”

Is anybody listening? It seems few investors are heeding the call.

CI reported recently that U.S. equity retail funds just saw another $2.9 billion outflow, the fourth in a row, and the 23rd of 27 outflows during the entire market surge October, and instead put another $9 billion in fixed income funds. As the chart below shows, while the S&P 500 Index has risen sharply, investors have tuned out instead of turning on.

 
Source: Zero Hedge

So far, this time is different. A combination of financial and economic realities (less credit, less liquid assets), along with changing demographics (aging baby boomers) and soaring distrust of regulators and Wall Street (is there really a difference?) have kept “Mr. and Mrs. Main Street” on the sidelines.

Underlying all of this is the great de-leveraging, a massive process that will take at least a few more years to play out. There's no telling when investors will get their animal spirits back and jump into the stocks with more fervor. Mostly it comes down to raw confidence and the genuine strength of the economy. Though the U.S. is moving in a positive direction, it will take further progress to shift the tide.

Meanwhile, nanocaps and other small stocks that largely depend on support from individual investors continue to struggle to gain traction. To break through to a wider following and build market momentum obviously requires more than incremental fundamental advances and well-positioned PR messages.

High Energy Stocks

The companies successfully transitioning from nanocap to mainstream microcap (e.g. Acorn Energy-ACFN), from mainstream to mature microcap (e.g. Antares Pharma-AIS and Curis-CRIS) and from mature microcap to bonafide small-cap (e.g. Maxwell Technologies-MXWL and Spectrum Pharmaceuticals-SPPI) have been among the best performers in our portfolio over the past year or two.

Like electrons in an atom, when a small company jumps into a higher orbit, it gains energy - as well as momentum. Based on this outlook I believe Elephant Talk Communications (ETAK) will soon make such a leap. For the smaller stocks in our portfolio it will take fairly powerful catalysts to produce a move, and I am confident that many of them will deliver higher energy returns this year.

Looking at what's on my radar, as I noted above I will be monitoring “fallen small-caps” and consider adding one or more to our portfolio at the right time. There is no reason we shouldn't take advantage whenever and wherever compelling investment opportunities appear.



The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of The NASDAQ OMX Group, Inc.



This article appears in: Investing , Stocks , Investing Ideas , US Markets

Referenced Stocks: ELON , RBCN , SGMO

Josh Levine

Josh Levine

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