How to Invest in Small-Cap Stocks

 

Some Common Small-Cap Questions

When You Should Increase Your Investment

When You Should Take Profits

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One of the most common questions I get from my Cabot Small-Cap Confidential subscribers is how to integrate my small-company stocks within their portfolios. In other words, they want to understand how my outside-the-box stock picking can fit into their overall investment strategies.

My reply is that my research doesn’t fall into any traditional style, such as distressed, value or growth, so it’s best to handle my small company stocks as a completely separate asset class. So if your portfolio is constructed in a traditional way, with fixed-income and blue-chip assets as a base and a diversified mix of sectors, geographies and risk levels, my picks will be in a class of their own.

Operating without a particular style works out well for me. Rather than place wagers on the economy or the markets, I focus strictly on companies that will produce products and services that will be in high demand in the future.

Today, those companies’ products and services aren’t clearly recognized or fully understood by institutional investors—but they will be someday. The payback for identifying big-picture trends and future high-demand stocks earlier than the crowd is venture-capital types of returns.

Unsurprisingly, these stocks can be very volatile. And that volatility should be taken into account when planning a portfolio—but not feared—because volatility can be very helpful to small company investors.

It’s for that reason that the Cabot Small-Cap Confidential advisory has two important parts. The first, of course, is presenting a high potential but undiscovered enterprise before it becomes a great stock. But the second part is also important; it’s providing guidance for taking advantage of stock-price volatility, which ultimately decides your profits.

Another common query from my readers centers on when is a good time to add shares to an existing stock position.

I often encourage investors to increase their holdings in a specific stock as we become more knowledgeable in forecasting market demand for the company's specific goods or services. This often happens when quarterly or annual reports show unexpected (or unexpectedly strong) growth in revenue or earnings. I also suggest adding shares when surrounding stock-market noise—like a correction in the broad market—reinforces the stock’s discounted valuation perspective.

Another topic my readers often ask me about is profit taking.

My advice on taking profits is simply pay yourself for assuming risk. I often recommend taking some profits when the stock appreciates 35% from the cost basis (or for very conservative investors, a profit that exceeds the stock’s historic returns).

But I also advise my readers to maintain their core positions after taking some profits because you don't want to clear entirely out of a trade when other market participants are still just learning about the company’s prospects.

A stock’s run doesn’t end when the company’s underlying competitive advantages become known. Rather, that can be just the beginning of a nice long run.

Your guide to small-cap investing,

Thomas Garrity
Editor, Cabot Small-Cap Confidential


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