US author Michael Lewis’s most famous book is Liar’s Poker.
In it he tells the story of working for U.S. broking firm, Salomon Brothers during the late 1980s. (It’s a must-read book if want to understand the early years of the subprime mortgage market.)
Lewis’s second most famous book – in America anyway – is Moneyball. Written in 2003, Lewis tells the story of cash-strapped baseball team, the Oakland Athletics (the A’s) and their general manager, Billy Beane.
(Unless you’ve got a basic understanding of baseball, we don’t suggest you read it.)
In short, baseball is a game where rich teams usually end up with the best players.
That’s a problem for the poorer teams as it makes it harder for them to compete.
Billy Beane’s task was to find a way to combat this problem. How? Well, even though he couldn’t outspend the big teams… he sure could out-think them…
Looking for Value and Growth in Small Cap Stocks
In any line of business many take conventional thinking as fact. In baseball, the scouts who watched college and high school players were sure they knew what made a first-rate player. If the player fit their conventional thinking they said he had the right “tools”.
Trouble is, not every hot young ball player with the right “tools” becomes a match winner. And the ones that do – and prove themselves on the pitch – don’t come cheap.
This is where Billy Beane had to out-think others. He had to ignore the traditional player evaluation process. And instead use an approach that would help him buy players other teams would overlook – because they didn’t have the right “tools” – but could score enough runs to win him games.
His trick was to use statistical analysis of a potential player’s past performance… something many other talent scouts hadn’t and still don’t think is important.
The result of this analysis was that Beane could find players the market had undervalued. So that even though the A’s wages bill was only one-third that of the big-spending New York Yankees, the team could still compete on almost equal terms.
Now, that’s all well and good for baseball and other sports. But how can it be applied to investing? Simply this: looking for value (and growth) is the core of small-cap investing.
You look for small cap stocks that are undervalued by other investors and where there’s the opportunity for explosive growth. You could call them small-cap Moneyball stocks.
And here are two of the best ways we know you could look for them…
Value the Small Cap Business, Not the Small Cap Share…
The simplest way to protect your wealth is to pay LESS for a share than it is actually worth… That is, try and buy shares worth $1 for 60 cents. And you’ll never go far wrong.
I’m not talking about haggling with your broker, or some kind of discount trading. It’s about knowing the difference between share PRICE and VALUE.
And with the sovereign debt crisis growing, in Europe and the US, it’s as important as ever.
Why?
Because when something “dramatic” happens in the world negative sentiment floods the market. This sentiment drags the price of good small-cap stocks (and bad small-cap stocks) down. And gives you the opportunity to buy good small-caps trading cheaply.
If you know how to find and buy a small-cap trading below its true value, you can use that knowledge to identify hidden profit potential. In any market.
So how do you work out whether you’re getting a fair price?
First, you need to stop thinking about buying small-cap “shares”… and start thinking about buying small-cap “businesses”.
When in Doubt, Follow the Dividend Trail
When you invest in a quality company trading below its intrinsic value, there’s a strong likelihood of it paying off in the long term.
Another rule of thumb when it comes to sniffing out quality companies is to follow the “dividend trail” back to its source.
Many investors write off dividend-paying stocks as “boring”. And unlikely to make you “real” money. But a company with a long track record of making dividend payments is probably less of a risk than a company with NO track record of paying dividends to its shareholders.
The reason being that it (generally) proves the company generates more cash than it needs…
That healthy cash buffer might be what separates a business that’s able to shake off the US debt virus from the ones that can’t.
If you buy a good dividend-paying stock at a fair price, over the long term you should receive a healthy mix of income and growth. And your wealth will be better protected against vicious collapses in the share market.
Play ball!
Kris Sayce
Editor, Australian Small-Cap Investigator
Two Down and Dirty Ways to Track Down Undervalued Small-Cap Stocks
