Issue 28

02/27/05

Increasing Returns Through Small Caps

Issue #28 - Increasing Returns Through Small Caps

1. Increasing Returns Through Small Caps

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Dear Friends,

Welcome back to Investing With Mom, after the hectic time I've had at
my other 2 jobs over the last 2 weeks, I'll be very happy when the day
finally comes that I'll be able to focus exclusively on Investing With
Mom.

To be perfectly honest, I almost feel as though I have a self-imposed
deadline of the one year anniversary of Investing With Mom.

For those who weren't here when we launched, Investing With Mom will
reach it's first anniversary on June 11th, 2005.

With that in mind, it is my fervent hope and prayer that I will be
able to increase the overall awareness of Investing With Mom to a
level where I do not rely upon my other jobs to subsidize this
business.

One reason for this, besides the obvious success of Investing With
Mom, is that one of my jobs is actively recruiting me to travel to
Seattle and Taipei, Taiwan for a combined month in May and June of
this year.

Now don't get me wrong, I'd love to have an all expenses paid trip to
either location, but upon the realization that I'd be working over 60
hours per week and wouldn't have access to my laptop, I considered the
possibility that it wouldn't be the best situation for Investing With
Mom.

I realize that it will work itself out over the coming months, but at
present I've begun to wonder how.

Hopefully, due to the fact that there are now in excess of 3000 of you
who receive this newsletter, there will be a recognition of the level
of service and advice provided to each of you who are paid subscribers
to the Advisory Newsletter and the soon to be launched Q-Timer Service.

Once that recognition begins to expand to an ever larger sphere of
readers, I will be able to provide an even greater level of service
than I am presently able to.

An indication that this is beginning is the meeting that I describe in
today's issue, enjoy!

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Increasing Returns Through Small Caps

Reading a recent commentary on small cap stocks, I found a common
theme with Investing With Mom and the style of research given to the
subscribers of the Advisory Newsletter.

"If you've ever walked into a Build-A-Bear
Workshop, you know what I mean.

"It is virtually a teddy-bear heaven for kids. A
child can pick out a skin for her teddy bear and
watch it being stuffed. After a "hug test," the
child can pick out clothes, shoes and accessories
for her new bear.

"The child can also put a wish or voice message
inside her toy. She even gets a bar code linked to
her teddy bear, in case it gets lost. This sort of
customization is fascinating not only to the
company's young customers, but also to much older
investors.

"The rage on Wall Street right now is retail
customization."

The problem is that Wall Street doesn't offer investment customization
to its smallest clients. Usually, you need at least $1 million liquid
net worth in order to qualify for the vast majority of private
specialized investment offerings.

Why else would Congress make it so that the $1 million liquid net
worth level is required to participate in private placements? They
know which side their bread is buttered on.

Well, about a week ago, I spent an entire 1 hour 15 minute lunch
appointment discussing potential investment strategies for a local
Dallas area investment club. While this club is associated with an
organization that prides itself on representing a wealthy segment of
the DFW populace, they are currently working with less than $200,000
and thus they barely qualify for some of the better risk reducing
investment strategies available in the markets.

While a significant portion of the lunch appointment was spent
discussing these private investments that can only be made by those
with large enough portfolios, we also discussed more mundane things
like boosting the club's returns.

Fortunately, there are several ways that they will be able to boost
their club's returns with minimal effort. Here is a discussion of just
two of the more obvious methods.

First, they need to replace their broker. Nice guy but he charges them
$75 per trade! Now you're probably thinking that you're doing okay,
because you only pay $50, $25, or even $15 per trade, but as I've
stated in the past, you can always increase your returns by lowering
your costs.

It's the no-brainer way to start improving your investment returns.

Buy and Hold is the company I recommend, but I am constantly searching
for a reasonable alternative. The only other company I know of is
currently searching for some venture capital and if they find it,
they'll be able to give Buy and Hold a run for their money.

Buy and Hold only charges $14.99 per month for unlimited trades, and
$6.99 per month for just 2 trades, with additional trades charged at a
rate of $2.99.

Now let's say this investment club only makes 1 trade per month, by
switching to Buy and Hold, they would save $68 per month, or $816
annually! By making the switch however, they could double their volume
to 2 trades per month and save an additional $900, without increasing
their costs one bit.

You might think that saving $1716 isn't much for an investment club
with nearly $200,000 in assets, but you've forgotten that the $1716 in
savings represents approximately 1% of the total value of their
portfolio!

This means that if they normally generate 7% returns on an annual
basis, they will have instantly increased their returns to 8%!

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The second way to boost the club's investment returns is by reducing
their exposure to large cap stocks.

It is a proven fact that larger organizations have a harder time
growing, shifting, expanding, reacting, or changing in any way.

Large cap stocks are no different, usually they provide nice, steady
calm, but anyone who reviews last year's markets will know that the
Dow Jones returned less than 4%. If that's the kind of returns you
want, fine but you can reduce your downside risk by buying bonds and
still generate the same returns.

As a quick comparison let's examine one of the stocks this investment
club purchased last year and compare it to a stock, that I recommended
since the launch the Investing With Mom, that most closely resembles
it.

Back in April, the club purchased 100 shares in Exxon Mobil (XOM -
NYSE) at a total cost of $43.02/share, unfortunately that means they
paid 62 cents per share more than the high for the day they bought
XOM, thanks to the commission they paid.

If they had used Buy and Hold instead, their commission would have
been no more than $6.99 for the trade, because they didn't place any
other trades in the month of April.

This would have reduced their cost basis to less than $42.35/share!

On June 21st of last year, in the 2nd issue of Investing With Mom, I
recommended that shares in Encana (ECA - NYSE) be purchased below
$44/share. I even compared ECA with XOM during my analysis of why ECA
was so cheap.

At the time, ECA's P/E ratio was under 9, whereas XOM's P/E ratio was
sitting on 14 and the Energy sector's average was at 15. Currently,
ECA's P/E ratio has increased to 14.2 and XOM's P/E ratio has inflated
to 17.6. By comparison, the sector P/E ratio average is now sitting at
21.2.

Let's say the club had managed to purchase on that date and had been
able to get the closing price of $42.76. For your information, my mom
and I paid $42.99 the very next day, as reflected in the IWM
portfolio.

When I made the recommendation, I placed a 12 month target of
$60/share on ECA and back on February 1st ECA closed above $60 for the
very first time, almost 5 months ahead of my target date!

Several of the more astute amongst you will point out that XOM has
also exceeded $60/share, as of this past week. However, a cursory
review of the two stock charts will reveal that while XOM has enjoyed
a nice runup in the last couple of weeks, it is definitely not the
same as the steady climb that ECA has enjoyed for the majority of the
last 7 months.

If anything, a sharp unexplained jump like what XOM has experienced
this month, should be cause for some concern and possibly even a move
towards selling part or all of the shares held, so as to lock in the
gains.

Whereas the steady rise of ECA has been accompanied by a 75% increase
in the daily volume of shares traded.

Let's wrap up this comparison by calculating the total current returns
for ECA and XOM, since their respective purchase dates.

XOM has been held by this investment club for nearly 11 months now and
if they had sold at Friday's close, after including their broker's
commissions, they would have generated a total return of 45.3%, in a
little less than a year.

Obviously, the sharp rise over the last month has boosted their
returns significantly.

ECA on the other hand, has been held by Investing With Mom for just a
little over 8 months and if we had sold at Friday's close, once
commissions have been included, we would have generated a total return
of 56.9%!

As a quick aside for Advisory subscribers, I have changed our outlook
on ECA and several other stocks and will be publishing those thoughts
in the upcoming issue of the Advisory. Please keep your eye's peeled
for a short note to be published soon regarding that issue. Thank you.

Neither calculation of returns has included dividends, which wouldn't
be significant for either stock, since neither one has been held for a
full year.

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Finally, if these returns had been locked in this past Friday, we
could also compare the annualized returns generated by the respective
sales. When these annualized returns are calculated, we discover that
XOM is on pace to generate a 62.2% return for the year and that by
comparison ECA is on pace to generate an outstanding 129.1% return!

Effectively, this calculation turns a simple 11.6% difference into a
66.9% margin in ECA's favor, more than double XOM's projected annual
return!

In conclusion, these are just a couple of thoughts to consider that
are vital to the success of any portfolio, whether you are a true
small investor, with less than $5000 in the market, or you are an
investment club with nearly $200,000 in total assets.

High commissions and fees will create an unneccessary drag on your
portfolio's returns that will prevent you from making any kind of
significant return on your portfolio, and as a result all fees should
be minimized if they fail to represent a reasonable return on
investment (ROI - in the glossary).

A smaller cap stock will usually generate a higher return, if all else
is equal. However, when you begin to factor in the fact that the
smaller cap stock is a better value, as defined by the P/E and P/B
ratios, then it creates an even bigger potential for higher returns
than the comparitive large cap stock.

There are always other factors to consider and you should never invest
just because a company's P/E and P/B ratios are lower, but if you have
already completed your due diligence and the decision comes down to 2
comparible stocks and the difference lies in the ratios...

Go with the cheaper, lower cap stock!

Investments good for my mom and you,
Andy Prior

PS. The March issue of the Advisory Newsletter, will include some
thoughts of mine regarding investments that are a bit unusual for most
small investors.

Not everyone will qualify for these types of investments, but then I'm
not selling them to anyone. I just want to make sure that everyone
is well informed and knows that they exist.

For access to the complete Investing With Mom portfolio,

...a discount on future services from Investing With Mom, including
the Q-Timer Service that will be officially launched in the coming
week,

...a pair of free airline tickets,

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