Big Profits To Be Made Investing In Small Companies - by Aaron Hoddinott

Congratulations to everyone who has made money during this month long record breaking rally. Give yourself a pat on the back because you refused to listen to all the doom and gloom theorists who claimed the financial world was on the brink of destruction just one month ago.
 
So now that the rally is a month old and the markets have climbed several percentage points, what do you do if you’ve missed the boat and were sitting on the sidelines? Do you jump in and hope there is still more upside?

I think jumping in isn’t a bad idea if you’re an investor with a medium to long-term time horizon, but you have to be careful because volatility is extremely high. Don’t just jump into any stock you’ve been watching, now’s the time to be selective and look for the right opportunities.

I believe the right opportunities right now are in the small cap stocks. Why you ask? Aren’t they too risky?

Yes, they are risky, but the RIGHT small cap opportunities are the companies with enough cash to get them through the next 12 months without having to look for money, or at least not large chunks of money (to avoid dilution), and they must have a superior asset. I’m not claiming that one particular sector is the way to go (although I really like commodities right now), but I think small cap stocks have the most upside – by a landslide.

Over the last six months small caps have been beaten down worse than any other stocks. This is because they were the first asset investors looked to liquidate due to the perceived risk involved with holding them during tough times. Investors’ perception and fear during this recession has given us a gift within the small cap sector.  Let me explain:

Because of this recession unemployment will likely be higher than 10% in the US very soon. Disposable income is very low, for now, but this will change as the savings rate quickly increases (already near 5%).

Disposable income is typically used by retail investors to purchase a nice new set of golf clubs, a new car, home improvements and most importantly, small cap stocks. People buy small cap stocks when they feel they are in a safe enough financial position to take on some high risk ventures. Not too many people have the money to play with high risk equities right now and for that, a lot of great small cap companies have been extremely oversold. Many of them didn’t even move during this massive rally. In fact, a few of the ones on my watchlist have gone down during this rally and they have incredible assets, no debt and enough cash in the bank to continue developing for the next 2 to 3 years!

The market moves 6 to 9 months ahead of the economy, right?

Not so for the small cap markets. These markets move when risk tolerance is high. They have trouble gaining traction during recessions and therefore trend differently from the large cap markets. Small cap markets have yet to show us the returns of the large caps because disposable income is still low (I want to remind you that this won’t last). This gives those investors who missed the rally a second chance at major profits, but they will have to be patient. Good deals are everywhere and positioning yourself in the small cap market now (with the RIGHT companies) is a smart move in my opinion.

As the economy works its way out of this recession and we inch towards positive GDP, the retail investors will come back to the small caps in a big way. The key is to