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Every so often, I like to check in with Cabot Small-Cap Confidential Editor Thomas Garrity and bring you his latest thoughts on the markets and individual stocks. I find his picks fascinating (from the latest medical discoveries to the technologies of the future) and the research he does on each investment is astounding.

Most of the Cabot newsletters have certain trading volume thresholds that must be met before we recommend a stock, but Tom's favorite stocks are often thinly traded, volatile and unknown to most investors. These stocks might sound risky (and they can be!), but investing in them can also have unbelievable payoffs.

So I was excited this week to see a stock that's long been a favorite of Tom's appear in Investor's Business Daily. The stock is EZ-Chip (EZCH) and Tom recommended it way back in October 2007. (Keep in mind that Tom recommends stocks for the long term.)

The company (formerly LanOptics) was started in 1989 and is headquartered in Israel. EZ-Chip develops Ethernet network processors for networking equipment. As consumers use more and more data from the Internet, EZ-Chip finds ways to deliver it better and faster.

This has proven to be a booming business. EZ-Chip's earnings climbed 1,250% in 2008 and 100% in 2009 and analysts expect EPS growth of 100% when the company reports on February 10.

EZ-Chip's earnings have increased 420% and 113% in the last two quarters and revenues grew 123% and 54% in the same period, with after-tax margins of 48% and 53%, the best in 17 quarters. Another plus is that the company has no long-term debt.

As mentioned above, EZCH is a thinly traded stock, moving only about 300,000 shares per day. But that's up from 200,000 shares a year ago, a sign that institutional investors have been moving into the stock.

Because the stock is so thinly traded (and because earnings are due out soon), I don't recommend that you run out and buy the stock. Add it to your watch list and decide whether you can tolerate the risk before opening a position. See how it reacts to earnings. A gap up could be a very bullish sign, whereas a gap down could spell trouble, at least for the short term. Or better yet, get Tom's latest thinking on the stock in Cabot Small-Cap Confidential.

You might be wondering how Tom discovers stocks like EZ-Chip before the rest of Wall Street. He uses tried and true investing criteria that can help you too if you're interested in small-cap stocks. Here are Tom's top tips:

* Make certain the company you're considering has enough capital to run its operations for many years and its balance sheet is (for the most part) debt free.

* Time your investment with a company-specific event.

* Get into a stock before institutional investors become aware of it.

* To the best of your ability, ensure that your investment has the highest probability for success. The proof will come from doing research and assessing data. Any company can fail, big or small, you just want to try to avoid being a shareholder when that happens.

* Only put capital to work in a stock that correlates with your investment risk tolerance and timeline.

* Finally, become committed to your investment, which means being comfortable with market volatility, and also having the patience to let it succeed.

Additionally, I did a Q&A with Tom last year and asked him to share some top investing tips for success with small-cap stocks. This is what he said:

"I have a lot of investment rules, but two of the most important are: 'Stick with it' and 'Don't be afraid to take profits.' As a small-cap investor, I tend to hunker down in an investment for the long term until institutional investors discover it. I find that sometimes waiting (which Jesse Livermore described as the way to make money) for institutional investors to arrive can be both a little boring and thought provoking.

"Let me elaborate. Small-caps are thinly traded, which generally means two things: 1) Little trading activity, for the most part it's you and a few other stock research enthusiasts holding the stock; 2) Since few trades occur in these stocks, the shares tend to trade with greater volatility than mid- or large-cap stocks.

"A lot of investors will sell out of a position because a stock is not moving favorably or quickly enough. The tragedy is that investors often sell out the moment the stock moves from its slumber past our purchase price, investors often sell out, missing out on tremendous moves in these stocks.

"I think you should stick with the investments that you've worked so diligently to research. Know that small-cap stocks can be finicky, but that eventually you'll get paid--in some cases many fold--for your research work and tenacity.

"When investors make big gains in their portfolios, they often don't want to sell their winning stocks. But not taking profits is a foolish mistake. You've got to pay yourself for your work. Whether you're inherently stubborn or you've just acquired a taste for greed, you need to detach yourself from this dangerous trait.

"The best advice I can give is, 'Collect rent for time well spent.'' I can't tell you how many times I have had the urge to take the multi-home run stock for just one more at bat. But taking another swing for more gains is risky business and you may well end up losing the lion's share of your profits or worse."

For more information on small-cap stocks, click here.

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In case you didn't get a chance to read all the issues of Cabot Wealth Advisory this week and want to catch up on any investing and stock tips you might have missed, there are links below to each issue.

Cabot Wealth Advisory 1/31/11 - Heaven Is ...

On Monday, Timothy Lutts re-capped his recent vacation to Switzerland and the economy of Switzerland. Tim also discussed a Swiss-based pharmaceutical giant that's a great conservative growth stock. Featured stock: Novartis (NVS).

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Cabot Wealth Advisory 2/3/11 - Don't Believe Everything You Think

On Thursday, Mike Cintolo discussed some investing truisms he uses that can help you become a better investor. He cautions investors, especially newbies, to avoid believing everything you think. Mike also discussed the current market environment and a stock that's a potential earnings play for next week. Featured stock: OpenTable (OPEN).

Until next time,

Elyse Andrews
Editor of Cabot Wealth Advisory

P.S. You read our newsletters, now show Cabot some love on Facebook. Click here to "like" our page!

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