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Smaller-cap stocks have been outperforming their bigger brothers -- and are likely to continue to do so, believes Michael Corbett, co-manager of the Perritt MicroCap Opportunities Fund. He cites two reasons: the much more attractive valuations of small-cap stocks and the fact that such issues tend to do better in a time of rising interest rates, which he expects to be coming soon.
The fund he co-manages is up nearly 40% since the market peaked in 2000, vs. a drop of 32% in the S&P 500 and large-cap issues, according to Corbett. The Perritt MicroCap Opportunities Fund has a strategy of buying stocks with market capitalization under $400 million, with between 80 and 100 names in the fund at any given time. Corbett made these comments in a chat presented Sept. 12 by BusinessWeek Online on America Online, in response to questions from the audience and from Jack Dierdorff and Karyn McCormack of BW Online. Following are edited excerpts from this chat. A complete transcript of this chat is available from BusinessWeek Online on AOL, keyword: BW Talk.
Q: Can you tell us about the fund you oversee, your performance this year, and how you go about choosing stocks?
A: Perritt MicroCap Opportunities Fund is a microcap fund. We invest in stocks with market capitalization below $400 million. We're generally a blend manager, which means we look for value stocks as well as growth stocks. We generally start there from a standpoint of screening for stocks. We're looking for companies with solid balance sheets and solid business models, and put our stocks through a proprietary nine-step test. Stocks must pass at least seven of the tests before we consider purchase. If they do, we then call management to decide if we're interested in purchasing the company.
Q: How big is the fund, and what are some of your top holdings?
A: The fund is about $16 million in assets today. A couple of the largest holdings we have right now: Blue Rhino (RINO
), which is basically a propane-tank exchange company. That would probably be a good example of a growth-oriented stock. Another big holding is Finlay Enterprises (FNLY
), which represents more of the value side -- a company in the retail jewelry business. They take care of the jewelry departments for most of the big department stores. The growth rate is not big.
Q: Michael, can you tell us how microcaps have been faring vs. larger stocks?
A: In the past three years, they've been faring exceptionally well. Our fund, in particular, is up close to 40% since the peak in the market in 2000, vs. the S&P and general large-cap market, which is down some 32%.
Q: Do you still hold on to stocks if they become too big to be considered microcaps?
A: Basically, our approach is, when a company gets too expensive in terms of valuations, then we sell. And the other reason we would sell is that it becomes too large. Our goal is to try to maintain a median market cap of somewhere between $100 million and $200 million in the overall portfolio. We will still sell a stock that is doing extremely well once it breaks $1 billion, but will most likely pick an exit point.
Q: Can you tell us what's the ticker symbol for your fund, the number of current holdings, if there is a load to buy or sell the fund, and the expense ratio?
A: Our ticker is PRCGX
. We currently own 81 stocks, and we keep it between 80 and 100 names. It's a pure no-load fund. There is a 2% redemption fee if shares are redeemed within 90 days of purchase, and the expense ratio is 1.75.
Q: Can you give us some more on your selection process? Companies down in the microcap arena would seem to be more of a gamble than the proven big boys.
A: As I said earlier, it starts with the companies with market cap below $400 million, and then we screen for companies that have low levels of debt and then that are attractively priced in terms of valuation, whether that be earnings valuation, book value, etc. Then we put each of the stocks through that nine-step test, and that model is really a screening of a company's balance sheet. From there, we call management, customers, and distributors and get as much information as we can about the company before we make the purchase.
Microcaps are absolutely a bigger gamble -- and that's part of the reason why we tend to own between 80 and 100 names. Since we've been in the business of managing microcap portfolios, we've found that a third of our companies reach their valuation target, another third are taken over, and the last third are mistakes. The net result is that we have been successful, and you can be quite successful in the microcap field as long as you pay attention to diversification.
Q: Small-cap stocks have been going strong for a while. Do you think they will keep beating larger ones, and why?
A: Yes, we think so. And the reason really has to do with a lot of fundamental factors, one of which is valuations. The microcap and small-cap fields trade at rice-earnings (p-e) multiples of [around] 15, the large-cap stocks trade around 20. Yet the growth rates for small-caps are much greater than for large-caps. Another reason to believe that small-caps will do well is that there tends to be a strong correlation to interest rates rising and small-caps performing well. Our belief is that, as interest rates will most likely be higher several years from now, rather than lower, small-caps will continue to do very well.
Q: Following up on stock selection, what have been some of your recent buys -- and biggest successes?
A: We really haven't bought a lot of new stocks recently. We tend to be a tad gun-shy in the summer months, as well as September and October. The only couple of stocks that we've added recently are Cray & Whitman Education (WIX
). In the past few months, we've actually raised cash and taken some losses on stocks to offset gains we had earlier in the year. So our dividend distribution will be minimal this year. We're raising cash with the anticipation of putting it to work in late October/early November, so we're not adding to any of our current holdings right now.
Q: Have you heard of Chicago Brewery & Pizza (CHGO
)? It packs them in like Cheesecake Factory (CAKE
).
A: Yeah, I've heard of it. And I never go near restaurants. And the reason for that is one bad experience from a customer typically leads to failure. Not to mention that the restaurant business has the highest failure rate in the country.
Q: Any comment on Fonar (FONR
), which makes MRIs?
A: I'm very interested in the company. I've been following it very closely. I don't currently own it, but it's on my Christmas shopping list.
Q: What weight would you recommend an investor with a long-term horizon give microcaps in a total portfolio?
A: Long-term? An investor should be between 10% and 20% in microcaps. The higher end would be for the ones that can tolerate volatility. There is a lot more volatility in the small- and microcap areas. It's also warranted to have a higher holding at this time, because the valuations are so attractive compared to large-cap stocks.
Q: How do you see the market for the rest of the year?
A: We're a little unclear as to what happens in the next several months or so. We believe there could be a really nice rally across the board as the end of the year approaches, however.
Edited by Jack Dierdorff
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