High-Potential Small-Cap Sectors

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Interview with Thomas Garrity

Most Attractive Sectors Right Now

Example of Small-Cap Pick: Questor Pharmaceuticals ( QCOR )

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Editor's note: This is the third in a series of interviews with Thomas Garrity, Analyst and Editor of the limited-subscription newsletter, Cabot Small-Cap Confidential . Click here to read part two

A lifelong investor, Tom has been a stockbroker, stock analyst, venture capitalist and portfolio manager. His long career and varied experiences taught him to make investments only when the odds of winning significantly outweigh the risks, and he applies this philosophy to every stock he recommends in Cabot Small-Cap Confidentia l.

Tom's disciplined investment methodology uses a series of qualitative and quantitative metrics that are evaluated for each company under his investment consideration. The company's products must target large markets, the science or technology must be proven, the balance sheet must be strong enough to support research or investment activity, and the idea must be strong enough to attract future institutional investment.

Tom's analysis results in a portfolio of stocks of companies that are pioneers in their areas of business. In most cases, these companies are creating whole new micro-industries, providing essential tools for an entire industry's growth.

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Paul: What small-cap sectors are particularly attractive right now?

Tom Garrity: At the moment, I'm focusing on software and hardware/information technology, health care and natural resources.

In hardware and software, I'm particularly interested in mobile payment transactions, digital content distribution and delivery and Cloud-based computing.

I expect that in the future mobile phones equipped with near field communications (NFC) technologies will allow a phone to be used as a payment tool for making purchases. NFC uses electromagnetic radio fields for securing contactless mobile payment between a smartphone user and another device such as a point of sale terminal. With an NFC-enabled phone, a person just waves or taps the device to establish a connection with the device reader and the transaction is complete.

As NFC applications grow, you and I won't need to carry around credit cards or driver's licenses-the phone will become a mobile wallet. Irrespective of how the economy is doing, consumers will want to access movies, games, TV, streaming news and other entertainment from their communication devices.

The consumption of digital content in a mobile world is growing uncontrollably. Today, video can be accessed from desktops, notebooks, TV, e-readers, tablets and smartphones with multi-touch capabilities. Hence, cable system operators, mobile carriers and other content providers want to deliver over-the-top services personalized just for their subscribers. In addition, just about every media company on the planet has plans to launch new products and services catalyzed by the metamorphosis from print publishing to online.

So I think the investment opportunities surrounding the trend away from print to digital delivery of interactive content will be found in companies that own the actual digital content rights, develop and publish content, provide tools for content creation or readying content for distribution, secure the content and/or provide the infrastructure involved in its delivery.

Businesses are adopting Cloud computing (formerly called software-as-a-service) as a way to eliminate hardware infrastructure needs and do away with the cost of maintaining host applications. Instead, with Cloud-based computing, all the software applications/hardware that business and consumers normally use to allow many applications to run are stored remotely on a dedicated server. Users can access applications on demand by using a simple browser on their mobile device over the Internet.

To remain competitive, all types of businesses will likely chose Internet-based storage and access of applications and shared services. I think companies that provide the tools to facilitate businesses transforming their services to a virtual Cloud platform will be favored investments.

Some other themes I'm incubating in the technology space include voice recognition software, Wi-Fi (entities with large coverage footprints) and M2M (machine to machine) solutions (remotely managing fixed-mobile assets).

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In health care, I'm looking at stocks of companies in the fields of targeted medicine, healthcare information or record management. Gene sequencing has opened up a wealth of techniques for finding out how normal and defective genes (and the associated proteins they make) play a role in a person's health. Today, diagnostic tools can detect the presence of some diseases based on a person's DNA and/or the presence of wrongly-encoded proteins. With this information, more effective pharmaceutical intervention is possible resulting in better patient treatment outcomes.

In pharmaceutical research, drug compounds can be formulated based on a person's DNA signature. In this way, when medicines are administered they are targeting the right patient populations where the drugs actually work and can be most useful. I have a keen interest in companies involved in genomic and protein testing as well as biotechnology companies that have proven methods to suppress or activate genes.

With respect to health care information, I'm interested in companies that assist healthcare providers in converting paper-based medical records to electronic form. When you go to your doctor's office, the receptionist reaches deep into a filing cabinet to retrieve your medical information. But it's not always that easy to obtain your medical records; sometimes one institution has to call another to have your medical records mailed to the hospital or doctor's office.

The HITECH Act passed in 2009 was intended to eliminate the need for searching round and about to obtain patients' medical records. This legislation allocated $19.2 billion towards improving healthcare by digitizing patients' complete medical records. I'm on the lookout for companies that are offering software tools to manage the automation of digital medical records or companies that ensure the flow/delivery of this information in a manner that adheres to HIPAA privacy and security rules.

Another area that plagues medical practices is keeping track of patient billing and submitting insurance claims for reimbursement of services rendered. Staying informed about payer changes, reimbursement coding and building reimbursement models is a challenge to healthcare providers. Companies that provide software that takes over back-office medical billing will be in high demand. So I'm looking at companies with the right algorithmically-driven solutions that cover both billing and reimbursement so that all claims are tracked and more get paid in a timely fashion.

Among natural resource stocks, I like water and shale (oil/gas). The owners of water land rights or pick and shovel companies that convert seawater or other liquids to water appeal to my investment sense. I'm also interested in shale oil/gas companies working in production and exploration capacities and suppliers of equipment to this industry.

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Paul: What's an example of a successful stock you recommended in Cabot Small-Cap Confidential?

Tom Garrity: A great stock I recommended to my subscribers in 2010 was Questcor Pharmaceuticals ( QCOR ) . Questcor manufactures an injectable drug called Acthar, which targets Multiple Sclerosis ( MS ) flares, Nephrotic Syndrome ( NS ) and Infantile Spasms ( IS ). I got on board with Questcor because ownership of this proprietary drug gives the company enormous pricing power, with little to no competition (alternative therapy) and a large dollar marketplace.

Questcor's Acthar is extracted from the pituitary of a pig, and its processing is a trade secret. The porcine adrenocorticotropic hormone (ACTH) differs from humans' by one amino acid. The composition of Acthar is further distinguished from either human or porcine in terms of its number of active peptides involved. Whereas active peptides in the pituitary exceed 100, the multiple peptides in Acthar are not fully charted. However, these peptides with multiple pharmacological properties would be most difficult to duplicate by even the most impressive pharmaceutical company.

The pricing for Acthar is $25,000 a vial, and for other indications where more vials are needed the pricing is significantly higher. While the total addressable market for Acthar for use in approved indications is large (a couple of billion dollars), off-label use such as rheumatology and Lupus carry the dollar value to even greater heights.

We bought QCOR at 9.38 in July 2010 and sold it when the stock hit our stop-loss of 40 in August 2012, for a profit of 326% in 25 months.

All the best,

Paul Goodwin
Editor of Cabot China & Emerging Markets Report
and Cabot Wealth Advisory

Related Articles:

Is Now a Good Time for Small-Cap Stocks?



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

Referenced Stocks: IS , MS , NS , QCOR

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