TMFMmbop (97.45)

Be Glad You're Not a Money Manager

April 30, 2009 – Comments (1) | RELATED TICKERS: USHS , FHC , BBSI

I got an email from the good folks at Roth Capital today (yes, the investment bank that throws the rock n' roll parties every year in Orange County [see photo]) pointing out that small caps are being denied access to needed capital due to the nature of this financial crisis. That's a problem for the companies, but could in the end turn out to be an incredible opportunity for you. Yes, you...the individual investor.

Here's what Roth had to say (note my italicized emphasis):

"The general economic malaise and diminished health of our financial institutions and real estate in the second half of 2008 resulted in the dramatic contraction of money allocated to investing in equities. Institutional investors and money managers have a certain amount of capital to put to use, and when their funding sources request that their money be returned or redeemed, the investors are often forced to sell stocks in their portfolio to obtain the cash to return. If there isn’t adequate demand for the stock to maintain equilibrium, the price of the stock obviously decreases as the selling increases. Many of the institutional investors in small cap public companies are funds with less than $1 billion under management. These smaller funds have faced larger redemptions (as a percent of the total fund) than the bigger brand name funds, resulting in even more pressure on stocks with limited trading volume. These requests for redemption and the fear that more may be coming in the future have led the institutional investor to rate liquidity in a stock above any other factor, including valuation, growth prospects, or sector bias."

What this means is that institutional investors would rather buy liquid stocks today than cheap stocks. That's silly, of course, buy they have good reason to do so.

You, on the other hand, absolutely do not. If you're a long-term investor who has some patience and the resources to cope with volatility, now is looking like a very good time to start scooping up some of the illiquid small companies (provided they have cash-rich balance sheets and don't need additional funding) that the market crushed in 2008 and early 2009 and that the most recent liquidity rally has left behind.

I mention this because someone asked recently about US Home Systems (USHS), a stock I own and have written about in the past. The market is up, but USHS continues to sit at $2. That's because nobody cares about it. Similar opportunities exist in the small-cap China sector. I recently bought shares of a small Chinese fertilizer company that fits this bill...though I don't mention the name and don't recommend you do the same given the potential for volatility and the fact that the Board of Directors remains a work in progress. (Please note that we do have a number of Chinese small caps that fit the bill and are ready for prime time as recommendations in Global Gains. Click here to become a member today and check them out.)

All of this is to say is that it's an interesting time to start building a basket or two of small, illiquid companies that have been unfairly sold off relative to their prospects, balance sheet strength, and quality of management. I save the China names for GG, but some domestic names that you might want to check out are Female Health (FHC), Barrett Business Services (BBSI), and SmartPros (SPRO).

Happy hunting.