Investing in Small-Cap Stocks: Anomalies are Golden

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By Josh Levine
Editor, MicroCap Investor 

Small stocks feel the effects when individual investors sit on the sidelines, as many folks are doing these days. In the MicroCap Investor portfolio, this is reflected in the absurdly low valuations for a group of emerging “game changers” -- companies capable of revolutionizing an industry with new technologies, products or therapies.

The good news is such inefficiencies in the microcap market present investors with opportunities rarely seen among larger tier stocks.

I’ve often reminded subscribers to recognize such anomalies for what they are, and to ensure they don’t make the kind of investing mistakes that have hampered the majority of individual investors. The biggest profits are made when you remove emotions from the equation and invest contrary to conventional thinking.

Most importantly, successful microcap investing is not simply buying once, holding, and then selling at some point. It is an ongoing process that constantly changes and requires us to make adjustments all the time.

Inefficiencies and Opportunities

Investing in small companies developing advanced technologies in the life sciences, energy, and communications is an adventure with enough ups and downs to keep the makers of Dramamine in business for a long time.

Such volatility comes with the territory for reasons we know so well. It is such behavior however, that at times creates severe anomalies in the valuations of microcaps.

When big inefficiencies in the market arise for small stocks, it presents great buying opportunities. This can best be seen in the recent trading activity of Antares Pharma (AIS), a company I once characterized as a “biotech for widows and orphans” because of its relative low risk versus its long-term upside.

As the chart below illustrates, AIS shares have experienced some wild swings during the past year. Most notable was the plunge taken by the stock on December 15 when it dropped 31% to close at $1.67.

As I said in my Alert at the time, the news that triggered the selling is “only a minor bump in the road for Antares. Today's 30%-plus drop in AIS shares is an overreaction and the stock will rebound fully in time.” I then concluded: “If you don't own AIS, I recommend taking advantage of this anomaly. If you were considering adding to your current position, this is the time to move.”

The shares traded as high as $3.45 on March 26, marking a gain of more than 100% in less than four months. AIS is now higher than its 2011 peak and trading at a level it hasn’t seen in a decade.

I am not implying that every time one of our microcaps plummets it automatically signals an immediate buying opportunity. Each situation is different and we must weigh a range of factors, starting with the news or event that caused the drop. In the case of AIS, it was abundantly clear the event was equivalent to a minor scratch, and the market’s overreaction was a gift for investors.

While a somewhat comparable anomaly and subsequent rebound also happened in Curis (CRIS) this past year (a stock in which we’ve got an overall 485% gain), reversals like the one Antares pulled off is unusual. What we typically see in market inefficiencies is less obvious. Often microcaps will trade down after heightened expectations are not met and investors either lose patience or interest.

Another microcap following this pattern is Elephant Talk Communications (ETAK), which has experienced a rollercoaster ride between $2 and $4 during the past 18 months. The recent slide, which began in early January with the stock at about $3, has been particularly frustrating since we were anticipating pivotal news about the first major contract with a global bank.

Based on everything I’ve been able to learn, ETAK’s outlook is as strong as it’s ever been. The deal is in place and I still expect to see a formal announcement when the bank goes live, which I estimate to be soon.

Under these circumstances, ETAK’s shares are ripe for buying. The pressure on the stock is temporary and based on the perception that the company will not deliver on the build-up of expectations. Once investors are assured of the veracity of the bank deal and other agreements in the works, then the stock will likely challenge previous highs.

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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: AIS , CRIS , ETAK

Josh Levine

Josh Levine

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