How to Invest Better Than a Venture Capitalist

June 21, 2005
Baltimore, Maryland

*** An Energized Small-Cap Rally
*** Small-Cap Clothiers Suited for Profits
*** How to Invest Better Than a Venture Capitalist
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Irwin Greenstein reports from St. Paul Street in Baltimore, where the wheels of drug commerce were interrupted in front of our offices yesterday, when seven police cars descended on a Cadillac with dark-tinted windows and hauled away the alleged gangsta...

*** Quiet rallies are the best -- exemplifying the true spirit of small-cap investing. We grab the profits before the crowd jumps in and then savor a juicy filet mignon at the Prime Rib while the herd shouts orders into a speaker of a Carl's Jr. drive-up window.

Last Friday, the small-cap S&P 600 hit an all-time high of 338.99 before settling in at 336.04, only a tad lower than the day before's close of 336.3. The S&P 600 started off the week by opening at 327.7 -- enjoying a mini-rally of 3.4% and a year-to-date gain of 2.1% as of last Friday. At the same time, the S&P 500 ended at more than 20% below its five-year peak with a year-to-date loss of 3.92%.

You could argue, in fact, that the small-cap surge started in May. For the month, small-cap growth funds returned 6.5%, versus large-cap value, the biggest style gainer, at 2.6%.

I've said it before, and I'll say it again. The flock of small-cap naysayers, whose
squawking was loudest in the beginning of the year, was wrong. Every so-called expert said it was about time that, after six years, small caps took their lumps at the hands of the large caps. The year started off that way, but 2005 could be a repeat of 2004. In mid-2004, the Russell 2000 small-cap index wavered before coming from behind to hit an all-time high in December. We predict a replay of that action later this year.

So where is the small-cap smart money going? We still think the energy sector will be hottest. That would include exploration, transportation and equipment. Case in point is small-cap Inergy Holdings.

Today was its first day of trading. In a lackluster IPO year, the propane company was expected to price in the $19-21 range. Fueled by Wall Street's enthusiasm for all things energy, the price was raised to $22.50. At the opening bell, Inergy hit $28.25…jumping to $31.25 as of 10:56 a.m.

If you believe in the adage that great minds think alike, then I'm flattered to share the same outlook on small-cap energy as our commodities options guru, Kevin Kerr..

*** "So once again, I am looking at my calendar and see it's time to pack my bag and head to our monthly gathering of the best financial minds in the industry -- or at least, those who would show up for the free food. Yes, I am talking about the monthly editorial meeting, where I get to hear from some of my favorite editors, analysts and world travelers from Agora in our Baltimore nerve center.

"This trip is extra special because it's my turn to (finally) buy my old friend Irwin dinner at his favorite French restaurant. I told Irwin to think of this dinner as a long-dated option trade that's finally coming in the money. He doesn't know it, but I plan to make the dinner pay for itself by picking my Sleuthy friend's brain on some small-cap gems…as I know he will reciprocate by filtering mine for any resource nuggets that may be a guide to small-cap buying opportunities.

"I do know from speaking with Irwin that he feels there are several small-cap energy stocks that stand to benefit from the most recent hysteria in oil. Is it hysteria or is it real, many have asked me. My answer is always the same. When you go to the pump and it costs you $40 to fill your tank, does it seem real to you? Perception (pain) is reality...that's the bottom line.

"So how do we play it? Well, there are certain sectors to buy. Look for small-cap drillers, transporters and even some drilling-equipment companies. Small-cap oil services in general are good, but you have to pick and choose. What to avoid at all costs? Small trucking companies and any industry dependent on transport, especially diesel. Why? These companies get crushed when diesel prices climb like this. Traders need to remember that diesel and heating oil are similar refinery products, and we refer to them generally as distillate. As most people know, demand for heating oil rises as winter approaches, just as demand for diesel grows as fall harvest season arrives. That competition for supplies drives up prices in a big way.

"Typically, history shows us that high gas prices encourage motorists to drive less. The result: Supply rises, demand falls, prices come down. The difference between gasoline and diesel is simple: Diesel fuel is used mainly by over-the-road trucks, trains, farmers and other businesses that can't simply cut back on fuel costs without risking going out of business.

"A chilling statistic: For every 10-cent increase in diesel fuel prices, 1,000 small trucking companies go under. And the trucking industry is principally small truckers. This basically is a nail in the coffin for small shipping and trucking businesses. Remember, avoid them at all costs.

"In turn, skyrocketing diesel prices raise the cost of production and shipping, which leads to higher consumer prices or lost profits or both. The fact of the matter is that diesel prices keep rising, and like the crazy real estate bubble, it may burst at any moment, but it is showing few signs of doing so just yet. What exactly that pain threshold is, and where demand slackens, I am not sure.

"In the meantime, as I feed my fine Sleuthy friend on Thursday night, I will pass on some more thoughts to him, and I am certain he will share them with you. Well, back to trading soybeans and orange juice over at Resource Trader Alert. Take care..."

Thanks, Kevin. Folks, if you can't have dinner with Kevin and me, do the next best thing: http://www.agora-inc.com/reports/RTA/WRTAF107.

*** Angela Roberts also believes that there's no escaping the rise in gas prices. Here, she talks about how it impacts a certain part of the retail sector...

"Yesterday, the S&P Retail Index (an index of high-capitalization stocks in the retail sector) closed at 451 -- very close to its early-January close of around 460. Analysts were quite happy with the news, because many believed retail sales would be hurt by the ever-rising prices in crude oil and gasoline -- the idea being that people are less willing to drive their 12 mpg SUVs to the mall. Despite that, large-cap retailers are surviving, and many are even reporting increased earnings in 2005.

"So what about small-cap retailers? After all, it is the small caps that have the intrinsic ability to move faster and reap greater gains in the short term. I took a look at the big companies included in the S&P index that are doing the best and found a few of their small-cap competitors. After all, for every five women still willing to pay $300 for a pair of shoes at Nordstrom, I'd guess that there are at least five more out there who are going to hit smaller shops for cheaper, but similar, alternatives.

"Nordstrom, a company that has a $9.5 billion market cap, is trading just under $70 per share -- a 50% increase from its January price. That's obviously a nice pop. But look at Bakers Footwear, a company devoted to mall-based shoe stores. It has a market cap of under $70 million -- much too small for the S&P Retail Index to notice. But since January, the stock has increased from $9.50 a share to $11. If you had bought back in November, when the stock was trading at around $7 a share, you would be holding a 60% profit.

"Or take The Buckle, Inc., a small-cap retailer of casual footwear, clothing and
accessories for young men and women. The company isn't included in any index and flies under the radar of most analysts and investors, with a market cap of just $833 million. Yet the stock has risen 50% since January, rising from around $30 a share to about $45.

"Jos. A. Bank is a designer and retailer of men's tailored clothing and is, incidentally, headquartered right here in Maryland. Back when I was filing in and out of the front door of Legg Mason every day, even I knew that every broker on Light Street wore a Jos. A. Bank suit at least four days a week. There was a Jos. A. Bank store right across the street from our downtown skyscraper, and it offered discounts to our employees, which lent to its popularity among all those bankers, brokers and traders. The stock, having traded at under $30 a share in January, has experienced a steady run and is currently pushing toward $45 a share -- yet another retail small cap with a 50% increase in just six months.

"Take a glance at the chart above. While the S&P Retail Index has improved over the past couple weeks, it has remained flat over the past six months. Yet our three small-cap retailers have accelerated. Our little experiment to surveysmall-cap retailers underscores the power of the small-cap market. The big dogs may catch the eye of Wall Street, but it's the little guys who will bring you quicker and greater returns."

Angela is right about small-cap retail. As one of the most overlooked sectors, it's filled with undervalued and underappreciated companies that make it prime for big gains.

*** Now, we hear from Jonathan Kolber, editor of The Emerging Capital Report. He'll tell you how to invest better than a well-dressed venture capitalist driving a 12-cylinder Bentley Continental Flying Spur...
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If these companies ONLY rise to their "fair value," you'll make 26%, 37%, 17%, 21% and 47%. And that's the WORST-CASE SCENARIO I see!

But if I'm right, you could make $254,973.40.

(And I've got 80 years of data that prove I'm right!)

I'll show you what five stocks you need to own right now to start you on your way to making 25 times your money.

I'll refund you the entire cost of your subscription if I am wrong. 

http://www.agora-inc.com/reports/FST/WFSTF623
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How to Invest Better Than a Venture Capitalist

Venture capitalists are some of the savviest investors in the world. They buy into early-stage companies, usually high tech, before the rest of the world knows about them. When they win, they win big: they can make hundreds of times their money on a single investment.

Although VCs are aggressive investors, they're also careful. They perform extensive due diligence. They focus on savvy management, strong business plans, and really valuable technology with proprietary barriers to entry.

There's a niche opportunity where you can do better than a venture capitalist. These are small public companies that VCs originally backed when they were still private. They went public, but they got into trouble somewhere along the way.

These companies can be better for at least two reasons (sometimes three). First, they are publicly traded which means you can buy and sell them any time. Venture capitalists typically must hold their investments for five to seven years. (It's still best to plan on holding these for years, not months-but sometimes you may unexpectedly need the money.)

Second, the due diligence process is more complete and more reliable because the small public companies are bound by Sarbanes-Oxley. This recent federal law mandates that small companies who lie to investors risk jail terms for their officers and directors.  Thanks to Sarbanes-Oxley, you can rely on information in companies' SEC filings, which is far more extensive than what VCs typically get to work with.

The third advantage is that these companies are often less expensive than when they were private. Having had their wings clipped by a bad event or two, they are no longer such high fliers. Their market capitalizations are lower. However, the potential is often still quite exciting. 

Here's the key: Many times, the stumble was not due to bad management but rather something external to the Company. Often, this is something that doesn't affect long-term prospects but just the current quarter. (I call this, "market myopia.")

In particular, I look for the little undervalued public companies I call "transformational technologies stocks."

Transformational technologies stocks are those capable of changing the world in some area. They don't offer a marginal improvement to the status quo.  Rather they have the potential to overturn a whole industry-sometimes several. 

Transformational technology stocks have three stages of life, kind of like a butterfly. 

During the first or "Caterpillar" stage, they wander around but don't seem to make a whole lot of financial progress. In this stage, they take in money from professional investors (usually, venture capitalists) and spend it on research and development. They burn through a whole lot of money, and rarely manufacture or sell anything. Such companies are subject to the vagaries of the stock market, and also to any news about them whether significant or insignificant.

It's best to buy these stocks during caterpillar stage, because no one can know when the next stage will start, or how fast it will unfold.

During the second or "cocoon" stage, the company is starting to succeed. It's "cocooned from the broader market". Its revenues grow rapidly as it begins to sell product and it moves to overturn an established industry. Constantly, the market capitalization and stock price rapidly increase.

In cocoon stage, price movements don't have a lot to do with the broader market. During this stage, transformational technology investing is an ideal diversification from other types of investing. It offers a kind of diversification that's unique.

Finally, during "butterfly stage", the company is discovered. It becomes front-page news in the mass media and moves from outsider to mainstream. (Genentech is an example of a company that made this transition in recent years.) Butterfly stage is the ideal point to sell. At this point, the most rapid price appreciation has already happened.

Remember, every Fortune 500 company of today was at some earlier time a
revolutionary.  Transformational technology investing is about finding those
revolutionaries early.

To your profitable future,
Jonathan Kolber

PS: Jonathan can show you how to make the profits of a venture capitalist. Click here: http://www.agora-inc.com/reports/VPI/nuclearC00

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