The Bull Hunter

*** Are Small Caps Overpriced?
*** Follow That Insider
*** The Bull Hunter

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James Boric reports from Bloomington, Ind....

*** For the last six years, small-cap stocks have been kicking the proverbial crap out of their large-cap peers. And this year has been no different.

Ellen Simon of The Associated Press reports, "The Russell 2000, the broadest small-cap stock index, has nearly doubled since 2002 and on Monday hit 671.74, its highest point since its 1988 inception; it closed Friday at 663.74."

Indeed, the Russell 2000 is up for the year. And it is outpacing the Dow, the S&P 500 and the Nasdaq - again. Still, I can't help but notice all the bearish sentiment in the air.

Simon writes, "As a class, small caps 'seem just a little too high at this point,' said Steven DeSanctis, small-cap strategist with Prudential Equity Group."

So your Penny Sleuth wondered is it time to sell? Is the small-cap cycle coming to an end?

To help answer that question, I ran a couple of screens. First, I ran a screen to determine which stocks were powering the market right now. I simply sifted through the major exchanges for stocks - any stocks, regardless of market cap - that closed at their 52-week high yesterday.

Twenty-four stocks popped up...and 22 were small-cap stocks, with a market capitalization of $1 billion or less.

This confirmed what we already knew: Small caps are in charge. You can see small caps' market leadership in another way too by looking at a chart of the ratio of the Russell 2000 to the S&P 500. When the line is rising, as it has been for months, small caps are dominating.

But it does make your dedicated Penny Sleuth take a beat. Even I wouldn't go out and buy a basket of stocks trading at their 52-week highs. So maybe it is time to sell.

Not so fast.

I called Carl "The GRIPPER" Waynberg to get his input. "Carl, what gives, man? Is it time to bail? Are the talking heads finally right?" Not missing a beat, Carl asked me if I had run any insider-buying screens of late - to see where the "smart money" was flowing.

I had not. But I did just that.

I built an insider-buying screen using the Zacks free screening tool. I looked for insider ownership of at least 10%, a net increase in insider ownership of at least 10% over the past three months and at least five insider buying transactions over the period, with no more than three insider selling transactions.

Here's what turned up...

1. Clear Channel Communications (CCU:NYSE), market cap $17.57 billion

2. Citizens South Banking Corp. (CSBC:NASDAQ), market cap $88.44 million

3. CapitalSource (CSE:NYSE), market cap $2.62 billion

4. Castelle (CSTL:NASDAQ), market cap 13.24 million

5. Republic First Bancorp (FRBK:NASDAQ), market cap $116.57 million

6. K2 (KTO:NYSE), market cap $598.77 million

7. NewMil Bancorp (NMIL:NASDAQ), market cap $133.16 million

8. Strategic Diagnostics (SDIX:NASDAQ), market cap $75.54 million.

All eight of these companies have steady insider buying - meaning the folks running the business are bullish on the future. What's interesting is...

There is only one large-cap company (Clear Channel Communications) and one mid cap in the group (CapitalSource). But my friends, there are SIX small-cap companies with significant insider support.

So despite the recent run-up in the small-cap index as a whole, there is obviously still value to be found in our favorite sector. Heck, based on this simple screen, 75% of major insider buying is happening in the small-cap universe.

But here's the kicker...

Of the eight stocks being gobbled up by their own CEOs, CFOs, chairmen and directors, half are either local banks or credit-services companies.

Check it out...

-- Citizens South Banking Corp. is a thrift bank based in North Carolina
-- CapitalSource is a credit-services company based in Chevy Chase, Md., that loans money to small businesses
-- Republic First Bancorp is a regional bank based in Philadelphia, Pa.
-- NewMil Bancorp is a thrift bank based in New Milford, Conn.

So why would small-cap banks be attracting so much insider money? Naturally, I called our resident expert on all things bank related - and a few other things, too - Chris Mayer. He's a 10-year vet of the business, as a VP at both Provident and Riggs Bank in Washington, D.C., and editor of Fleet Street Letter. Here's what he had to say...

"It's really simple, actually. The bigger banks are having a harder time growing in this market. Take Citigroup, for example. It disappointed the Street yesterday with its growth numbers - coming up a nickel short of earnings expectations. So one way to fix the problem is to buy cash-rich thrifts...like the ones popping up on your insider-buying screen."

Chris continues...

"Because small regional and thrift banks tend to have a lot of capital and a lot of cash, they are naturally great acquisition targets. And that's what you are seeing right now. These small fish are ripe for the picking. That's why the insiders are loading up. They know if the larger banks come after them, they will walk away with a nice premium."

By the way...

Chris Mayer recently recommended a thrift company to his Fleet Street readers. Talk about insider buying...since last April, insiders have dropped over $3.7 million of their own money in the stock. And as I type, it is about 45% undervalued compared to the rest of its peers. Oh yeah, it's also sitting on over $101 million in cash - making it a perfect takeover candidate.

To learn more about Chris and his thrift bank, check out his report on the cheapest companies on the market right now: http://www.agora-inc.com/reports/FST/WFSTF431 .  

*** As the second half of the year plays out, we'll find out if small-cap stocks will end up ahead of their large-cap buddies. But I can assure you of one thing...

No matter what happens to the Russell 2000 or the S&P 600, there will always be small-cap stocks worth owning. According to MultexNET, there are 8,632 companies trading on the market. Of those, 6,554 are small-cap stocks with a market cap of $1 billion or less. That means...

Small-cap investors have three times the universe to choose from. And here at Penny Sleuth, we're confident there will always be something worth owning.

When there is, we'll let you know.

*** We recently streamlined Penny Sleuth to help you make more money faster. We'd really like to hear your opinions about the update. Love it? Hate it? Somewhere in between? Email us at thesleuth@AgoraFinancial.com

*** I now pass the torch on to Dan Denning...

Dan is the editor of Strategic Investment and author of the best-selling book The Bull Hunter.

Like your Penny Sleuth, Dan looks for big themes in the world and figures out ways to make money from them. Of course, the rise of the small-cap stock market has been as big as any theme in the world for the past three years. So I wondered how Dan might take advantage of this situation?

To find out, I read The Bull Hunter last week, and there was one part that I thought you absolutely needed to read. You see, Dan doesn't care whether small-cap stocks rise or fall. He's found a way to profit no matter what happens...and it doesn't involve buying any stock at all.

So here's an excerpt from The Bull Hunter... ________________________________________________________

America's Leading the World to Financial Ruin!

So says the world's greatest living economist... 

And after seeing the REAL numbers - the ones mainstream "analysts" never even look at - I have to say he's absolutely right. 

The brutal truth is that the U.S. economy is a brittle house of cards. 

But you don't have to blindsided when it all comes crashing down - not if you've got the facts - and the expertise to parlay them into major profits... 

http://www.agora-inc.com/reports/RCH/WRCHF706

A SMALL-CAP STRATEGY

The Russell 2000 is an index of small-cap stocks. The index is designed to tell investors how small-cap stocks are doing as a group. It makes it easier to compare small caps to, say, the Dow 30 or the S&P 500. Because small-cap stocks are often growth stocks and highly volatile, they can be a leading indicator of a broader rally in all stocks. From a business perspective, it also makes sense. Small firms are at the front lines of the economy. They are the most sensitive to changes in business conditions. When the economy is growing, small firms see it and profit from it first. That's why investors love to scoop up small-cap shares at the end of a recession. They know that small-cap stocks will rise as the fortunes of small-cap companies improve. 

What you may not know is that you can buy all 2,000 stocks on the Russell 2000...in one single stock. Let me introduce you to IWM, or what is formally known as the iShares Russell 2000 Index Fund. 

IWM tracks the Russell 2000. When you buy IWM, you are essentially buying the performance of the Russell 2000, much as when you buy the triple Qs, you're buying the performance of the top 100 Nasdaq stocks. Figure 3.1 shows you that IWM does clearly track the Russell 2000 (RUT). This is an important correlation to look for. You want to make sure the ETF you're buying actually imitates the performance of the index or underlying commodity it's designed to track. You can do so by constructing a chart that resembles Figure 3.1 or, more easily, by consulting the prospectus of the ETF you're looking at. As you can also see from Figure 3.1, in the large market rally that began in the spring of 2003, both IWM and RUT have clearly outperformed the Dow, leading the market up.

It's nice to know your theory of small caps leading the market up is correct. But another benefit of ETFs is that you always know what's in the basket of stocks you bought. You can view individual holdings and see them broken down into sectors. I'll tell you why this is important in just a moment. But first, look at Table 3.1. This shows you the top 10 holdings in IWM and the top 10 sectors and industries the individual holdings fall into.

Knowing what you own isn't just a convenience. It's essential. With ETFs, you always know what you own. That means you also know what you're buying before you've ever spent a dime -- something that's not always true with mutual funds. It's a good idea to check what an ETF's holdings are. For an ETF like IWM, it's easy. The ETF has the same holdings as the stocks in the underlying index, in this case the Russell 2000. The same is true for other index ETFs.    

But not all ETFs are index ETFs. In fact, as they become more possible, you can expect more ETFs that slice the market into smaller ideas. If you're a precision-guided investor, this is good news. It means that for virtually any investment idea or theme you have, you'll be able to find an ETF that matches it. You'll have a simple way to directly benefit from your idea, without the risk of buying just one single stock. However, with the variety of offerings comes the burden of deciding which one to buy. 

--Dan Denning 

Ed. Note: 

We recently made a wager with Dan: If his new book, The Bull Hunter, didn't surpass Thomas Friedman on the amazon.com bestseller list, within two weeks, he would have to wear a sarong to this year's Agora Wealth Symposium in Vancouver. 

[To get your ticket to the conference, click here: Agora Wealth Symposium - August 10-13, Vancouver, B.C. http://www.awsymposium.com/psleuth/ ] 

Unfortunately for Dan, he didn't nudge Friedman out of his spot on the bestseller list, and it has been exactly two weeks. So, we hate to break the news to you, Dan, but you will be donning your green sarong at this year's conference.  

Dan may have lost the bet, but Friedman's reign on the bestseller list needs to end soon - and you can still help knock him off. Just click on the link below to purchase The Bull Hunter: 

http://www.agora-inc.com/reports/RCKN/BH/    

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