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April, 2011


For better or worse, the Easter season combines in our culture elements of the religious and pagan and is at once a time of celebrating a spiritual breaking of the bonds of mortality and, in the northern hemisphere, breaking out of the confines of winter's dormancy, reduced daylight, and severe cold. Traditionally, I support a relatively conservative, value oriented approach to investing. Over the long haul, such a stance seems to provide good risk-adjusted results.

However, in honor of April, both its fools and celebrants, I thought it might be fun for a change to suggest an experimental investing strategy based on another form of breaking out. It has great possibilities. I call it "Little Cap Big Mo with a Bo." One starts with nano-cap to micro-cap stocks ($50 million to $500 million market capitalization company stocks), screens for a specific range of price earnings (4-25), and limits the results further to only those with a dividend, three-month average daily volume 125,000 shares or above, 52-week price change of +25% or above, and a dividend payout ratio no higher than 0.5. From among the stocks meeting the above criteria, it seems best to select the top five, measured by their prices being the lowest percentage below the stocks' 52-week highs. Develop and maintain a portfolio of five stocks. (Do not include limited partnerships.)

Rebalance after the portfolio as a whole is up 5% or more, or after three months, whichever is first. As one may surmise from this qualifying data, the approach makes the most of both small capitalization (the "little cap" part of the strategy's name, since smaller market cap stocks tend to outperform large capitalization ones) and price momentum. In addition, there is a bonus, the dividends the portfolio provides. The yield adds to the total return. Further, smaller capitalization stocks that offer dividends generally have lower risk and better performance compared with their non-dividend paying cousins.

The final bonus part of the "bo" in the name comes from a modest use of margin debt. On average, micro-cap to smaller capitalization stocks have provided total returns since 1926 of about 11-12% a year. Those with dividends do somewhat better, so make that around 13%. I would tweak this a little with margin debt, buying enough new shares when the markets are down to assure that, after all expenses, one gets from this strategy around 15% a year or better, averaged over five years, enough to at least double one's money in that period of time.

Is this a guaranteed money machine? Absolutely not. I refer to it as experimental for good reason. However, it has performed quite well in the first few months I have tried it. To date it is up at an annualized rate of just over 43%.

Here are the current companies that, effective with the close of trading on 4/19/11, meet all aspects of the criteria:

CPKChesapeake Utilities Corp.$41.4615.203.10%48%
DESTDestination Maternity Corp.$23.5014.470.70%11%
DNBKDanvers Bancorp, Inc.$21.6123.750.60%11%
FRDFriedman Industries, Inc.$10.3711.653.40%16%
INTXIntersections, Inc.$15.1513.673.10%27%

If living dangerously holds interest, and you wish to try this approach, it is best to do so in tax-deferred accounts since, if it is profitable (as one of course hopes), there will be plenty of short-term gains. It also probably should only be tackled with a small proportion of one's overall liquid assets. (My own experiment was begun with a bit less than 2.5% of our net total.) If the approach works out well, though, that low percentage part of the nest egg will naturally grow in a rather satisfactory manner.

In view of the strong momentum aspect of this investing technique, some surprisingly value related qualities may be uncovered in the stocks meeting the requisite filters. For instance, among last quarter's winners was one, TICC, with then a greater than 8% dividend and low debt. Amid the current batch, though their trailing dividend percentages are each 3.10%, already well above average, the projected forward dividends of both FRD (4.40%) and INTX (4.10%) would meet the Ben Graham criteria for bargain stock status. Since dividends are often paid quarterly, holding the stocks for three months or longer (if they have not averaged gains before then of at least 5%), helps assure this strategy will harvest some income in addition to the assets' price performance.


Larry is not a professional. Don't take him seriously!

Actually, the investment article provided here is for general information only and should not be considered as professional advice, a solicitation to buy or sell any security, or the Word of God. Investors are encouraged to do their own research while considering their personal goals and circumstances, or consult their own professional financial advisors, before making investment decisions. Neither Larry nor LARVALBUG will be liable for any losses sustained by any visitor to this site.

(Disclosure statement: Larry and Val have holdings in some of the suggested assets but do not "make a market" in any of them and do not derive any direct benefit from recommending them, except perhaps for a bit of smug self-satisfaction.)

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