But micro-caps can be worthwhile holdings, says Hal Ratner, a chief investment officer of Morningstar Investment Management. The smallest stocks sometimes diversify portfolios and deliver winning returns, Ratner says.
To appreciate the potential rewards and risks, consider Aegis Value
The periods of outperformance often compensate for the occasional disappointing years. During the past 10 years, micro-caps returned 12.1% annually, compared to 8.5% for the S&P 500, according to Morningstar/Ibbotson. "Micro-caps can be volatile, but they can give you the potential for strong returns," says Hal Ratner of Morningstar.
To hold micro-caps, try a relatively steady mutual fund. Top managers can earn winning returns by combing through the ranks of obscure companies and finding bargains. A solid choice is Wasatch Micro Cap Value
While the average market capitalization of S&P 500 stocks is $54 billion, the Wasatch portfolio has an average capitalization of $496 million. Portfolio manager Brian Bythrow sometimes buys companies with market capitalizations of less than $200 million. "We want to find small companies that will grow to be bigger businesses," he says.
Most of the tiny stocks receive little attention from Wall Street analysts. In contrast, major blue-chips are covered by dozens of analysts. Bythrow aims to spot growth companies before Wall Street discovers them and pushes up the prices.
One of his successful holdings was First Cash Financial
Wasatch currently owns BofI Holding
But he says that the Internet bank is a cautious operator, typically loaning only 55% of the value of a house. The stock currently has a capitalization of $506 million. "This will be a $1 billion company in five years," Bythrow says
Another strong-performing mutual fund is AllianzGI Ultra Micro Cap
In other instances, he will take companies that appear to be poised for turnarounds after periods of stagnation. Last year the fund enjoyed a special boost when several of its holdings were purchased at premiums by bigger companies. Marren said that his stocks often make tempting acquisition targets. "Corporate purchasers like to buy companies with good growth prospects and low valuations," he says.
The fund recently bought Marlin Business Services
Another recent purchase is Rudolph Technologies
This article was written by an independent contributor, separate from TheStreet's regular news coverage.
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