Small cap stocks still lead the pack
Small cap stocks are staying ahead of large caps in the market, says this U.S. advisory, which has eight to recommend, six from Canada.
A few economic maxims have bitten the dust in this young century.
Such as, in any given 10-year period, stocks will make a handsome real return of 5 to 6 per cent. Didn’t happen. How about corporate bonds beating government bonds? Nope.
But one of these truisms is holding up, says a major U.S. advisory. Small cap stocks have come out ahead of large caps.
But how the heck did that happen, asks Mr. Stephen Leeb, editor of The Complete Investor? In a decade that had two bouts of deflation and fears of depression, small cap stocks should have been clobbered.
Inflation is usually good for small caps, but except for a brief appearance in 2008, it has been conspicuously absent.
And yet America’s small cap index, the Russell 2000, has mostly stayed ahead of the large cap S&P 500 since the turn of the century. (For a quick comparison, the S&P/TSX Small Cap Index is about three percentage points ahead of the large-cap S&P/TSX 60 Index so far this year.)
There is a reasonable explanation for this, says the editor. Small caps may respond better to government stimulus spending.
In turn, this advisory thinks investors may want to respond by considering eight small caps it likes — six of which are Canadian.
A full six-pack
During the Great Depression, Mr. Leeb tells us, both large and small caps had negative nominal returns, but positive real returns due to the lack of inflation. But from 1927 to 1937, small caps did better.
Yet after the economic debacle of 1937, small caps fell, as investors were unsure how the government would respond to the latest setback.
In short, says this editor, small caps do better when there is moderate or strong growth, “or when government actions have reassured investors that such growth would emerge. They’ve underperformed only when real economic activity has been declining with no clear prospects for improvement.”
Massive spending and loose monetary policies will eventually lead to inflation, he adds, but as long as it’s accompanied by some positive economic growth, small caps should stay ahead of their big brethren.
There is one caveat, however. Rising commodity prices could hurt small caps by pushing up costs. So this advisory picks out eight stocks that are bound to benefit from rising commodity prices. That gives the selection significant Canadian content, a full six-pack in fact.
Low costs, rising production
We’ll begin with a favourite of this advisory, NovaGold Resources (TSX/NYSE-NG), which we featured a month ago (see Daily Buy-Sell Adviser, February 25).
The advisory likes its massive reserves of gold, copper and silver and its deep-pocketed partners, like Barrick Gold (TSX/NYSE-ABX). Trading at $5.87 a month ago, Nova has moved back up to $7.68, close to its 52-week high of $7.80. There is no dividend.
Three more of the Canucks are precious metals stocks. The other gold entry is Red Back Mining (TSX-RBI; OTC-RBIFF). It has low costs, plentiful reserves and rising production and it trades at $20.24.
The same winning parlay of low costs and growing production is an advantage for Pan American Silver (TSX-PAA; OTC-PAAS). This stock trades at $24.08 and is the only one of these four gold and silver stocks to pay a dividend. It yields 0.2 per cent on $0.05.
Silver Standard Resources (TSX-SSO; NASDQ-SSRI) has potential reserves of 75 million tons — three times the world’s annual production of silver. It hasn’t always done a great job of production, but with a new CEO the rewards outweigh the risks, says the editor. The shares are at $18.03.
Running on all cylinders
The other two Canucks are energy services firms. Ensign Energy Services (TSX-ESI; OTC-ESVIF) is solidly entrenched in western Canada and California and has now moved into the famous Haynesville shale gas region as well as the Gulf of Mexico.
Profits dropped last year, says Mr. Leeb, but should be “running on all cylinders for the next several years,” making it one of the cheapest companies of its kind based on today’s valuation. It trades at $14.67 and yields 2.3 per cent on its $0.35 dividend.
Trican Well Services (TSX-TCW; OTC-TOLWF) is a more aggressive play, says the editor. It’s doing a lot of shale drilling in North America and Russia. It’s a leader in pressure pumping, which is particularly important in Russia. Growth in Russia is the key to its future, since its business in the U.S. is down. A recovery in America would be “icing on the cake.”
With its modest valuation, Trican could also be a takeover candidate. The shares are at $13.09 and the $0.10 dividend yields 0.7 per cent.
There’s also an oil services firm on the U.S. side. Atwood Oceanics (NYSE-ATW) posted higher earnings in 2008 and 2009 when others were in down. Long-term, it should achieve growth of 15 per cent a year, says Mr. Leeb. Yet it has a single-digit price/earnings ratio today. It trades at $34.53. There is no dividend.
Finally, there is a U.S. potash firm. Intrepid Potash (NYSE-IPI) is the biggest producer of potash in the United States, which allows it to take local customers away from rivals like Potash Corp. of Saskatchewan (TSX/NYSE-POT) — which is in this advisory’s Growth Portfolio, by the way. While it’s not an international giant like Potash Corp, it does export many specialized fertilizer products. It may also be a takeover candidate. It trades at $34.73, also without a dividend.
These eight stocks have the potential to double over the next two to three years, says Mr. Leeb. Of course the risks are greater, “so don’t bet the farm on just one,” he adds. Buy at least three, he tells his U.S. readers, or if you can, all eight.
At least try the six Canadian stocks, we’d be tempted to add. But we’re biased that way.
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