Interview with Thomas Garrity
Is Now the Time to Invest in Small-Caps?
Tom's Criteria for Selecting Small-Cap Stocks
Editor's note: This is the second in a series of interviews
with Thomas Garrity, Analyst and Editor of the
limited-subscription newsletter, Cabot Small-Cap Confidential.
Read part one here.
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.
He applies this philosophy to every stock he recommends in
Cabot Small-Cap Confidential. His 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.
Because these stocks have little or no institutional or
research coverage, Small-Cap Confidential subscribers can
acquire significant positions in these companies more cheaply
than if their stocks were widely followed.
Is now a good time to invest in Small-Cap stocks?
The economic recovery may stay muted due to a confidence crisis
by both investors and businesses owners brought on by the
uncertainties about the health of the global economy. The
macroeconomic picture reveals weighty unanswered questions
relating to investment and GDP growth such as the debt crisis in
Europe, political instability, Fiscal Cliff aftermath, tax
expirations, Obamacare and continual high unemployment.
Uncertainty surrounding the reconciliation of such important
engines for capitalism will likely persist into 2013. Since the
stock market gets its cues from the pace of production and
consumption of goods and services, even a perception of a slowing
in any of these underpinnings can pressure small-cap equity
However, the best opportunities for small-cap investors are
often in just such times of risk-aversion! Fear can create
mispricing of small-cap stocks, allowing us to pay less for
stocks with great growth potential.
The most important factor powering the performance of
small-cap stocks is economic growth. During times of improving
supply/demand conditions and rising interest rates, small-cap
stocks tend to outperform large-caps. Studies involving past
rates of returns have shown that when an economy regains its
footing, small-cap stocks are the first group to rise. In 2012,
the small-cap index measured by the Russell 2000 was up
With the backdrop of a weak economy, I expect small-caps
indexes to post impressive gains in 2013, and my stock selections
to be considerably higher.
What qualities do you seek in a company/stock before you
recommend it in Cabot Small-Cap Confidential?
The first thing that attracts me to any particular company is how
excited I can get about their new products.
To start, here's what I avoid: Products tied to the economic
cycle, products that can be mass produced, products that are
subject to continual price competition, products that participate
in a marketplace with many competitors, products that are more
than a year away from getting to market (unless it's a
biotechnology company), products that are capital-intensive and
products with low profit margins (in the absence of scale
The company that earns a spot on the
Cabot Small-Cap Confidential
focus list looks like this: A unique enterprise that's a pioneer
in a start-up field, with products ready to launch or about to be
commercialized very soon.
Since the company is producing a never-before-seen gadget that
offers a fresh way of doing something, I can label the business
as leading edge. Because the company's products/services address
or solve a growing need, target a very large end-market and are
in high demand, the potential for sales growth is
The final ingredients needed to earn a spot in my small-cap
stock focus list are that the company must have 1) quality
management and 2) a clean balance sheet.
Regardless of how radical and compelling the company's
offerings may be, unless the leader running the show is an
evangelist, the fruit will die on the tree. However, when company
leaders are adept at spreading the word about their innovations
with the kind of conviction that converts prospects into
customers, then I know I'm closer to being in the right
Lastly, I look for a balance sheet that has little debt, a
stock with few shares outstanding (too many shares spoils the EPS
porridge) and cash on the books to fund operations for a couple
of years before sales take off. This makes for a satisfactory
All the best,
Cabot China & Emerging Markets Report
Cabot Wealth Advisory
What Makes a Successful Small-Cap Investor?
Sign Up for our Free Cabot Wealth Advisory