Love affair with micro-caps can sting
Many of the best opportunities in the sector lie outside U.S.
If we’re in the later stages of this remarkable bull market — as many are arguing in the wake of the stock market’s all-time highs this month — then so-called micro-cap growth stocks should perform spectacularly.
These are the stocks of companies whose market caps are among the smallest of any publicly-traded firms and trade on the assumption their earnings growth will be among the fastest. Such stocks have produced an average annualized gain of 79% in the last three months of all bull markets since the mid-1920s, according to the bull market calendar maintained by Ned Davis Research and data compiled by Dartmouth finance professor Kenneth French and University of Chicago professor and Nobel laureate Eugene Fama.
There’s a catch, however — a big one: The rest of the time, these stocks, on average, have produced a small loss.
That makes good stock picking crucial when it comes to microcap growth stocks. These stocks tend not to be widely followed — making it difficult to obtain information about how the companies are doing. In most cases, their names are ones you’ve never heard of before.
Unfortunately, one of the sources to which investors have turned for help has decided to discontinue. The Oberweis Report, which has been published for 40 years — the last 20 of which by Jim Oberweis, president of Oberweis Asset Management. The newsletter’s editor during its first 20 years was Jim’s father, also Jim Oberweis, who currently is a member of the Illinois Senate.
Since 1988, according to performance tracking by the Hulbert Financial Digest, the Oberweis newsletter’s model portfolio beat a buy-and-hold in the stock market by 1.8 percentage points per year on an annualized basis.
I spoke with the younger Mr. Oberweis, and he most definitely is not giving up on the sector:
“I’d say we’re in the later stages of the bull market; we’re not in the first, but not the ninth inning either — perhaps the sixth or seventh.”
Oberweis had several reasons to shutter their newsletter, including regulatory burdens and publishing ’s diminished profitability. But there also was an investment rationale: Their belief that many of the best opportunities in the micro-cap sector now lie outside the U.S. — and beyond the scope of their newsletter, which focuses only on issues trading in the U.S. “Only about 10% of our firm’s assets under management are in U.S. equities right now,” he added.
One of the reasons foreign micro-cap stocks offer more opportunities is that fewer research analysts follow them, Oberweis said, which means it’s easier to find stocks with huge potential. The market for U.S.-traded micro-cap stocks, in contrast, has become increasingly efficient. In terms of market inefficiency for micro-cap stocks, “foreign markets are where the U.S. was a number of decades ago.”
Another factor to take into account is that micro-cap growth stocks tend to be extraordinarily volatile. Portfolio diversification therefore requires owning a large number of them.
Oberweis recommends at least 30 to 40. There are also high transaction costs. Investors will not only need to pay a commission to your stockbroker but another one for exchanging dollars into the foreign currency.
Because of these challenges, you may want to pay a mutual fund manager to do the work for you. If so, the shuttering of the Oberweis Report will have no impact, since you can still follow Mr. Oberweis by investing in one or more of his fund offerings, such as the Oberweis Emerging Growth Fund (OBEGX), which has produced a 7% annualized return over the last three years, according to Morningstar. That’s far better than the nearly 3% annualized loss for the average U.S. microcap growth stock over the same period, according to data from Fama and French, though it lags the large-cap dominated S&P 500’s 11% dividend-adjusted return.
Other mutual funds in the micro-cap growth sector include the TFS Small-Cap Fund (TFSSX), with a 6.9% annualized three-year return, and the Bridgeway Ultra Small-Cap Fund (BRSIX); with a three-year return of 4.5% annualized.
One of the sources that investors used for help — The Oberweis Report — has decided to discontinue.