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Look for smaller stocks to lead in the market -- but if you go into micro-cap names, be sure to diversify. Such is the advice of Michael Corbett, senior vice-president of Perritt Capital Management and manager of the Perritt MicroCap Opportunities Fund (PRCGX
).
The fund Corbett runs, with $25 million in investments, owns between 80 and 100 stocks, with health care the largest sector included. Corbett says his favorites in health include Lifeline Systems (LIFE
) and Healthcare Services Group (HCSG
). The largest single holding, however, is Matrix Service (MTRX
), which specializes in above-ground storage for oil and gas companies.
In shopping for stocks, Corbett says he looks for companies with market capitalization below $400 million and strong balance sheets or cash flow. In coming days he expects to see strength in energy, technology, and specialty retail companies. In that last sector, he likes Ashworth (ASHW
), which makes golf apparel, and he says he's studying other possible purchases.
Corbett made these and other comments in an investing chat presented Mar. 20 by BusinessWeek Online on America Online, in response to questions from the audience and from Jack Dierdorff and Karyn McCormack of BW Online. A complete transcript of this chat is available from BusinessWeek Online on AOL, keyword: BW Talk.
Q: Michael, aren't micros too volatile for individual investors?
A: They are if you don't diversify your portfolio properly. You can't buy a handful of them -- you have to buy a good, broadly diversified basket to make them worthwhile. That means anywhere from 50 to 60 or more names.
Q: How has your micro-cap fund been doing relative to other parts of the market?
A: It has been doing well -- we're down modestly this year, but we've been up each of the last three years, which is a great performance compared to the broader market. We do foresee this continuing. In fact, I would expect the performance of small- and micro-cap stocks to take leadership in this market.
Q: Is the fund widely diversified within the micro universe?
A: Absolutely. We currently own nearly 90 common stocks and have just about every industry represented. We always try to keep between 80 and 100 names in the portfolio at all times.
Q: How do you pick those names from the multitude?
A: Basically, we start with companies under $400 million in market cap, and then we only pick companies with strong balance sheets or strong cash flow. From there, we put each and every stock through a proprietary nine-step test. After that, we do good, old-fashioned, fundamental analysis.
Q: What is your largest industry?
A: That would be health care. We own about 14 names in health care, and some of our favorites include Lifeline Systems (LIFE
) and Healthcare Services Group (HCSG
).
Q: Do any tech stocks look good to you now?
A: I'm 50/50 on techs. I have a few tech stocks that I like. One I own now is Captiva Software (CPTV
). Captiva is trading at less than one times revenue, they've signed up a few nice contracts, and my analysis shows that the company should earn between 30 cents and 40 cents this year -- and the stock is under $3.
Q: What do you do if one of your investments grows beyond $400 million in market cap? Sell and reinvest?
A: No, we let them run to usually somewhere around $1 billion, but more of our sell discipline is along the lines of valuation and how much coverage, or how well it's known, in the marketplace. Our sell discipline is based on individual stocks and analysis, not formulas.
Q: Why has the S&P 600 lagged the general market? Don't small-caps generally lead us out of a bear market?
A: They do, but it never works right in the beginning. Basically, I wouldn't look at it from the standpoint of what happened in the last few months, I'd like to see what happens one year out or so. My guess as to what sectors will lead the way would be energy, maybe some areas in technology, and believe it or not, specialty retail.
Q: Can you list some of your energy holdings?
A: I mentioned Matrix Service already. A couple of others are Layne Christiansen (LAYN
) and Harvest Natural Resources (HNR
). Both of these stocks have performed in line with the market the last few months -- nothing substantial in either direction.
Q: And what about another area you expect to lead -- picks in specialty retail?
A: I have some investments related to specialty retail, such as Ashworth (ASHW
), which is the golf-shirt apparel company. I have several specialty retailers that I'm looking at but haven't purchased yet.
Q: Do you ever invest in a company that has yet to show a profit but looks promising? That was a pattern during the bull runup, of course.
A: We do, from time to time, but we always make it a point to ensure that the majority of our portfolio is filled with companies that have profits and a history of profitability.
Q: Over the short term -- three to five years -- what percentage of a personal portfolio would you have in micro-caps?
A: I generally would recommend somewhere between 5% and 15% of one's portfolio. That's a general guideline. If you can say you definitely have a longer-time horizon, I would recommend a higher allocation than that. I wouldn't say that number has changed because of market conditions, but there's the argument that small- and micro-caps will do well coming out of the bear market, so that's a good argument to own some stocks in the space if you don't already.
Q: How do you manage the risks inherent in so many smaller stocks?
A: By owning a lot of them. After that, it's watching the percentages that you have in each stock. If one stock starts to move up too fast and become a big percentage of the portfolio, we start selling regardless of what the fundamentals are.
Q: What about gold in this market? Any thoughts on Royal Gold (RGLD
)?
A: I don't know Royal Gold, but I'm somewhat interested in the gold market. I think there's something to the rally we've seen in the past 24 months. In fact, I own one company that is related to the gold market -- it's actually a money manager called U.S. Global Investors (GROW
). The future of gold? That's a difficult question to answer. But the short answer would be that gold prices will generally stay in this range, which will bode well for the gold-mining stocks.
Q: What is the dollar size of your fund?
A: We have a little less than $20 million. We usually keep between 3% and 5% of that in cash.
Edited by Jack Dierdorff
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