Small Caps

[IntheDraft6]

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I'm looking for opinions on small/micro caps. I recently purchased some small/micro cap mutual funds (AUMIX and GSMAX). My advisor (who I think is a little overly conservative) says to get rid of them as he feels the 5-7 year outlook is negative. In my limited google search I have come across mostly positive forecasts in regards to small caps. I'm 37 and have a high risk tolerance over the next 10-15 years. Thoughts? What is a good source for more research that is up to date?
Thanks.

 

[Catalino21]

Have you looked into Biotech ETFs? PBE (PowerShares Dynamic Biotech & Genome portfolio) is a biotech ETF that has more exposure to small caps/startups in the sector than other ETFs. Most of the others have a significantly higher portion of their portfolios invested in the big boys such as Amgen and Biogen.

You could also look into trading individual biotech/pharma small caps. These obviously have huge upside potential every time they get an FDA approval. As a physician, you probably have better insight than most into deciphering a company's drug research and potential impact on the market. There are obviously a ton of companies to sort through so start by just reading through some analysts picks and watching CNBC. Take down some names and read through their quarterly reports then make your own decisions.

Small caps always should have a place in your portfolio because of their huge upside. Your not gonna get a 200% + gain from the GE's, McDonalds, and Microsofts of the world.

 

[IntheDraft6]

As a physician, you probably have better insight than most into deciphering a company's drug research and potential impact on the market.

Yeah, that's what I thought until I lost about 40% on AMRN. Turns out I know a lot more about medicine than I do the FDA and govt regulatory issues, lol. I'm long so we'll see how it turns out.

 

[Catalino21]

Yeah, that's what I thought until I lost about 40% on AMRN. Turns out I know a lot more about medicine than I do the FDA and govt regulatory issues, lol. I'm long so we'll see how it turns out.

I've never traded or kept up with them mostly for that reason. I just suggested it because your an attending and I thought you could wade through releases and reports better than myself 😛.

Also think about playing small caps betting on the housing comeback. I got in on RDN, a mortgage insurance lender, a little over a month ago. It's up a little over 10% in that span (after being down over 4% today👎). Any sort of construction or furnishing companies could be worth looking into.

 

[The White Coat Investor]

Does your investment policy statement really say "Try to predict which types of stocks are going to do well in the future by talking to an advisor who thinks he can predict the future and scouting around on the internet and then just buy those stocks?"

Have you ever thought about what that policy statement ought to say?

 

[IntheDraft6]

My policy says nothing like that. I diversify and rebalance once a year, which is about now. I have my advisor look over my porfolio while also doing my own review (I'm still learning so I like to have someone else look it over). When my research on a part of my porfolio disagreed with what my advisor said I just figured I'd seek out a few other opinions, knowing that there are some people here (such as yourself) who are reliable sources. As for AMRN, that was just some extra "play" money I had and not part of what I consider my real portfolio.

Love your blog and thanks for the input.

 

[Tenesma]

Think of what motivates an advisor....

then get rid of said advisor...

 

[The White Coat Investor]

My policy says nothing like that. I diversify and rebalance once a year, which is about now. I have my advisor look over my porfolio while also doing my own review (I'm still learning so I like to have someone else look it over). When my research on a part of my porfolio disagreed with what my advisor said I just figured I'd seek out a few other opinions, knowing that there are some people here (such as yourself) who are reliable sources. As for AMRN, that was just some extra "play" money I had and not part of what I consider my real portfolio.

Love your blog and thanks for the input.

For the record, I do hold lots of small/micro caps in my portfolio. In fact, I hold all of them. I use BRSIX, a mostly passive ultra small company fund by bridgeway. The expense ratio is a little high (0.87%- actually the highest in my portfolio) but it's only 5% of my portfolio.

In my experience, doctors hold no edge over the professional investors when it comes to picking one small cap stock over another, even within health care related fields. Picking individual stocks is taking on uncompensated risk. Why run a risk you don't have to and for which you aren't compensated? Just buy them all. Other reasonable options for buying really small stocks include IWC and PZI.

 

[grivacobae]

IMO, small cap stocks or funds don't bode too well with advisers, as they want a steady and conventional increase in their return, don't want to have a huge possible downside which comes with small cap companies, if anything, you should do your own due diligence, if you have the time. That includes company filings, governance, and press releases and all that jazz. If you believe you don't have time then an adviser doesn't either with everything else, especially for small cap. Plus, it's not too difficult, in fact it's 'fun' and interesting to say the least. For example, I am 19 now but at 18 I started with small cap stocks (penny stocks). I did a stock screen of possible stocks in industries that will generate and be the next 'bubble', though energy (which i decided on) is not a bubble. I found CSIQ at 1.75 this past November, with many hours of due diligence and occasional monitoring, i bought $3000 worth of shares at 2.50, already up from low. Sadly by the time college bill arrived, couple months later, I had to pay and sold at 4$, all 3000 shares. Now, as i suspected, but not as much frankly, the price per share for CSIQ is 30$... from 1.75 to 32.39 in a little over 10 months, this is the wonder of small caps, their beauty is just disguised and undervalued, it's a game that advisers shouldn't and don't like playing, it's a game that risk takers thrive on, and that't the key, risk, only a few funds have that type of risk and they're the most prestigious, hedge funds. Advisers should't be advising penny stocks when they are there for conservative individuals, the majority of the population. You should be your own intelligent investor.

 

[grivacobae]

Yea sorry actually fully read your post and saw that your going through small cap funds, not individual adviser, disregard half of my last post haha, sorry.

 

[The White Coat Investor]

Penny stocks are not the same as small caps. Heck, they're not the same thing as microcaps. I don't know of a single investing authority who recommends penny stock investing. Far too much pump and dump going on there.

 

[SouthernSurgeon]

As a physician, you probably have better insight than most into deciphering a company's drug research and potential impact on the market.

Yeah, that's what my surgery resident friend thought when he moved most of his money into intuitive stock early this year. Whoops.

 

[IntheDraft6]

Yeah, that's what my surgery resident friend thought when he moved most of his money into intuitive stock early this year. Whoops.

LOL. What I have learned is that I understand the science and the drug but as a physician, I have a horrible understanding of how consumers and even more importantly, the government work. I lost a small amount on AMRN, thinking Vascepa was a good idea and the science seemed sound. I know someone who invested heavily in APPY when they were above $5. He even had multiple docs look at the studies, including the research guru at the teaching hospital. He has lost close to $1M since he invested. He's decided he will need to work for a few more years.

 

[souljah1]

Trying to predict the market is a loser's endeavor. You have to realize that if you decide to try and time the market you are competing against hedge funds and investment firms who spend millions on trying to research companies to leverage insider information. You stand no chance to "get in early."

Much better to hold index funds and indirectly hold the market. If you want to "tilt" toward small cap value then do so - but trying to pick individual funds will burn you much more than it will make you.

 

[grivacobae]

Penny stocks are not the same as small caps. Heck, they're not the same thing as microcaps. I don't know of a single investing authority who recommends penny stock investing. Far too much pump and dump going on there.

Actually Penny Stocks are just a way of saying stocks that are trading under 5 dollars a share, to some stocks it is literal but to others its figuratively. I'm thinking you're thinking about Pink Sheet stocks, and possibly OTC (those are markets where companies can go public in btw, kinda like NYSE and NASDAQ but not with as strict requirements). And if you're going off of "authorities" to guide YOU'RE personal investments, stick to what they offer, their amazing index's with astonishing 1-3% a year!
And to the Pump and Dump schemes, those are stocks that are usually advertised in those "Stock Emails" or whatever, again, going off of others, and these really do screw you over. If you can do your own due diligence, with out opinions of others, I'd recommend that. Don't get me wrong, accept opinions and be open to them, but with a grain of salt.

 

[grivacobae]

Trying to predict the market is a loser's endeavor. You have to realize that if you decide to try and time the market you are competing against hedge funds and investment firms who spend millions on trying to research companies to leverage insider information. You stand no chance to "get in early."

Much better to hold index funds and indirectly hold the market. If you want to "tilt" toward small cap value then do so - but trying to pick individual funds will burn you much more than it will make you.

I don't try to predict the market at all, hell not even Warren Buffet can predict the market, and he admits to it. It's about waiting for the market to value a company correctly, or to over value, or to under value. So in reality, I search for companies that the market has undervalued, and just wait until it has corrected, there are LOTS of companies that don't have analyst coverage, and once they do and you found that company before them, then they'll start pumping money into it along with other followers and that's how it get overvalued by the 'market'. That's when you sell, so all you gotta do is buy cheap sell at value or over, there's no market prediction, it's just a waiting game if anything.

 

[The White Coat Investor]

Actually Penny Stocks are just a way of saying stocks that are trading under 5 dollars a share, to some stocks it is literal but to others its figuratively. I'm thinking you're thinking about Pink Sheet stocks, and possibly OTC (those are markets where companies can go public in btw, kinda like NYSE and NASDAQ but not with as strict requirements). And if you're going off of "authorities" to guide YOU'RE personal investments, stick to what they offer, their amazing index's with astonishing 1-3% a year!
And to the Pump and Dump schemes, those are stocks that are usually advertised in those "Stock Emails" or whatever, again, going off of others, and these really do screw you over. If you can do your own due diligence, with out opinions of others, I'd recommend that. Don't get me wrong, accept opinions and be open to them, but with a grain of salt.

I think you're seeing a distinction where no one else does. Investopedia basically considers Penny Stocks, OTC stocks, and Pink Sheet stocks to all be the same thing, as do most investing authorities I know of.

Definition of 'Penny Stock'

A stock that trades at a relatively low price and market capitalization, usually outside of the major market exchanges. These types of stocks are generally considered to be highly speculative and high risk because of their lack of liquidity, large bid-ask spreads, small capitalization and limited following and disclosure. They will often trade over the counter through the OTCBB and pink sheets.

If you want to be an individual stock picker, I suggest you carefully track your returns and compare them to a portfolio of very low cost index funds of similar risk. If after 5 or 10 years you're beating the pants off it (after expense and after tax, and including the value of the time you spent doing it), then keep doing what you're doing. You may very well be the next Warren Buffett. But if you're like most, it won't take you long to realize that stock picking is a loser's game. Most stocks pickers I know of not only have no idea what their return has been, they don't even know how to calculate it.

 

[grivacobae]

Yea

They will often trade over the counter through the OTCBB and pink sheets.
You may very well be the next Warren Buffett.

I'm not saying that Penny Stocks aren't Pink Sheet stocks, I'm saying stocks that trade under $5 generally can be called Penny Stocks, be it in Pink Sheet, OTC, or Nasdaq. What I was saying is that yes, penny stocks are small cap stocks and micro cap...?, and more. I mean what else do you call 10M - 500M market cap stocks trading in the Nasdaq trading at .25 a share? Just because they're in Nasdaq and not in lower tier markets doesn't mean they can't be considered Penny Stocks, we differ in definitions I guess.
And I'm not trying to be the next Warren Buffet, but I am trying to be smart and take risk at a young age, there's nothing wrong with being Financially Literate at 19, and maybe making a name for yourself in your 20's with your aptitude for stock selection.

 

[The White Coat Investor]

Remember to only take compensated risks. Individual stock picking is generally not thought to be compensated. Since the risk can be diversified away, the market won't compensate for taking it.
And that's not even considering the risks unique to penny stocks. Academic studies have found the average return on penny stocks is -32%. That's the wrong sign in front of the return in my book for a smart investment.

Bjorn Eraker and Mark Ready just put out a paper entitled, Do Investors Overpay for Stocks with Lottery-Like Payoffs? An Examination of the Returns on OTC Stocks. They find:
In our nine year sample, approximately $820 Billion traded in the OTC markets. This represents less than a month of typical NYSE volume. Still, the OTC markets are not insignificant: the average stock in our sample lose about 15M dollars from the first observation to the last. In total, stocks in the OTC market lost approximately $180 Billion of market value over our sample period. These numbers themselves are conservative because we did not make any assumption about the value depreciation taking place for stocks that no longer trade.

http://falkenblog.blogspot.com/2011/01/penny-stock-risk-premium-has-wrong-sign.html

Here's another good one.

http://www.business.uq.edu.au/sites/default/files/event/supportingDocs/ghon rhee paper.pdf

Finance and investing has its own literature, just like medicine. That literature is uniformly against this asset class. Ignore it at your peril. Note that the second paper makes the distinction you make- that there are listed and unlisted penny stocks, and the listed ones are less risky and more likely to provide a solid return (like microcaps and small value stocks).

 

[grivacobae]

Remember to only take compensated risks.
http://www.business.uq.edu.au/sites/default/files/event/supportingDocs/ghon rhee paper.pdf
"The negative connotations of penny stocks are well-known. In fact, the pejorative
perceptions that are associated with penny stocks include (but are hardly limited to) the following
issues: the extreme illiquidity and high volatility of these securities; “pump and dump” and “short
and distort” schemes; the propensity of these stocks to be involved in e-mail spams and other
types of internet fraud; attempts to sell penny stocks through boiler-room operations involving
cold calls; and the reputation of these stocks as gambling-like investments. Many websites and
newsletters that promote investment in penny stocks even insinuate that they can help investors
make enormous returns of 500% or even 1000% in a short period of time."

This is where and when Penny Stocks become well known to the public, the famous schemes brought on by pump and dumpers and shorters. Like I said, those emails and calls and all that are clearly those schemes, and yes those investments are plain dumb. I agree with the first article and that the SEC should really try and get the major investors (the cause of pump and dump schemes) to really tone it down.
But, again, like i said, there are penny/small cap stocks that are yet unknown by these investors and contrary to belief, have good financials one can research and value, and conversely value the company. Take for example my example, a penny stock according to the second articles description, CSIQ, trading at low of $1.75 I believe, unknown and cheap, I did my due diligence (what separates investors from speculators) and it is now trading around $40-45 consistently, no scheme pulled off there, and this stock trades in the Nasdaq. That's just one example, there are many undiscovered and undervalued stocks with good financial standings, or showing that their future financials will be promising. That's what I'm trying to get at, I'm not saying all penny stocks are good and plausible investments, I'm saying that there are coal look a likes that have no choice but to turn to diamonds, you just gotta find them, they are masked with label of "Penny Stocks - The Worst Investment".
Also, those studies have no choice but to include the pump and dump schemes, the businesses that failed (which is a pretty astonishing number, isn't it half of the businesses that start will fail withing 1 or 2 years? and then half of those withing 4? ), so there are clearly more of those than the unknown stocks. The averaging out of this one sided study is where they supposedly get their negative return on average on all the penny stocks, making each individual seem like the worst possible investment, but from the returns I've gotten (i can show proof), they really aren't, and it just grinds my gears that people are naive to this just because it's frowned upon by the public and advisers.
Do you really think if an adviser was good at picking stocks he would be making a living from advising someone? Has Warren Buffet ever been an adviser?

 

[grivacobae]

But in all honesty, this skepticism towards these stocks actually aids me with even more unknown and undervalued opportunities, so from this we both probably take home that I love arguing!😛 No harm done though 😀

 

[The White Coat Investor]

I have no doubt there are very talented investors out there who truly have the ability to pick stocks that will outperform the market. I think they are few and far between. You might be one of them. You might also be lucky. Or perhaps you don't know how to calculate a return. Or perhaps you're lying. I have no idea. But I don't think I personally have the ability to choose which penny stocks will do well and which will do poorly. Trying to do so without that ability is highly likely to lead to returns of, oh, about -32%.

I wish you good luck investing, and seriously mean that. But I'd be pretty careful encouraging others into this particular corner of the investing universe. A viable investing strategy among listed stocks is to simply buy them all for a very low cost and hold them a very long time. That strategy does not work with penny stocks, no matter what definition you use. Since the Beta is -32%, the alpha is everything. Your alpha needs to be not only better than 32%, but enough better to make up for the fact that you could just buy a total market index fund (and make 7-10% long term) and spend your time doing something else. Be very humble about your abilities and calculate your return carefully, including a value for the time spent researching stocks. If after 5 or 10 years you're doing great, by all means continue. If you find you aren't quite as talented as you had hoped, well, you'll still be pretty young.

 

[Pseudopseudonym]

Yeah, that's what my surgery resident friend thought when he moved most of his money into intuitive stock early this year. Whoops.

Anyone who put in adequate time and effort would realize that daVinci is likely not worth the amount that it costs. If you look at the actual data (just search on NEJM), you will see that outcomes (generally) are the same, or worse, than traditional surgeries (either open or laps) for a significantly higher cost. The resident friend you speak of likely just saw a cool piece of technology and thought it would be cool to be "in" on the stock. When push comes to shove and ObamaCare sets in, costs will have to be cut drastically. How are health systems going to justify spending millions on equipment that has no data to support it's use? (Disclaimer: I, too, think that daVinci is an awe-inspiring piece of engineering technology.)


And to the discussion re: penny stocks: just because something is OTC/pink sheets or <$5 does not mean it's a bad investment. On the contrary, I'd say that if due diligence is done, there is the most potential for mispriced securities. An example of a recent investment of mine is PSTX which sells the surgical sponges that have to be scanned in/out when they are used to prevent retained products. It was recently bought out by Stryker for a 30% premium. The stocks that are listed on OTC/pink sheets, etc are volatile and illiquid, but that is not synonymous with "risky" - just a different type of investment. I'm sure you all know this, but I just wanted to weigh in my 2 cents.

Good luck out there!