The Great Eight and the Blue Chip Myth

By Greg "Gunner" Guenthner
Feb 26, 2007

The Daily Reckoning PRESENTS: There has been a lot of chatter in the media lately about the return of blue-chip dominance...but our resident small-cap virtuoso points out that by passing over the small stocks, many investors are missing the big picture...and big profits. Read on...

In the few short months since the New Year began, eight investments have more than doubled.

There was no fanfare... There was hardly any mention of the gains in the Financial Times or on any financial television network... No major fund managers announced a drastic change in strategy to capitalize on the trend... And the average investor sat on his hands, settling for the mediocre returns he may or may not get through some index fund or assortment of familiar companies with household names.

These eight investments all have one thing in common. Along with 39 of their peers, they have been the most profitable picks of 2007, with the top returns ranging from 52% to a whopping 22,000%. That's right...47 out of 50 of the biggest gainers of the past 6 weeks all belong to this one investment class.

The big-money secret? All eight are small companies...

The "Great Eight" I've been writing about all have market capitalizations of less than $1.5 billion. Just look at these stellar returns:

Top Eight Performing Penny Shares, 2007

1. Towerstream Corp. (TWER) - 22,174%
2. YTB International, Inc. (YTBL) - 266%
3. Optionable, Inc. (OPBL) - 192%
4. Onyx Pharmaceuticals, Inc. (ONXX) - 128%
5. Research Frontiers, Inc. (REFR) - 117%
6. China Precision Steel, Inc. (CPSL) - 112%
7. Hoku Scientific, Inc. (HOKU) - 107%
8. Overhill Farms, Inc. (OFI) - 105%

However, most investors have decided to ignore these stocks...

You see, there has been a lot of chatter in the media lately about the return of blue-chip dominance. One particular Associated Press headline caught my eye a few weeks ago. It read: "Signs Point to Good Year for Investing in Large-Cap Stocks."

The article says it might be time for small-cap investors to rethink their stock picking strategy. The author thinks this year, the best bet for anyone with a dime in his pocket will be the big-name stocks. The logic is that eventually, large-cap, blue chip returns must have a special year where they whip the Russell 2000 - a benchmark group of 2000 stable small-cap stocks with proven, long-term performance.

This could very well happen... But this argument misses the bigger picture.

First, let's get some stats out of the way. The Russell 2000 posted a gain of more than 18% for 2006, officially beating the Russell 1000 Large-Cap Index for seven of the last eight years. However, the Russell 1000 caught a second wind and slammed the Russell 2000 for the second half of 2006.

Ever since the Russell 2000 took a hit in May, a lot of money has been flowing into large-cap stocks. Meanwhile, the Dow Jones Industrial has soared while the Russell 2000 and the NASDAQ have lagged behind.

So that's the whole story as far as most investors are concerned. The Dow is hitting record highs twice a week and small stocks are dead in the water. If the Great Eight prove anything, it's that this is completely false.

In fact, only three members of the Dow Jones Industrials are showing double-digit gains so far in 2007: General Motors, Alcoa and Caterpillar (up 18%, 16% and 10%, respectively). While these early returns are nothing to scoff at, they hardly compare to the best performing smaller stocks.

The glaring problem with these over-quoted index-based statistics? They completely disregard any shred of stock selectivity. Instead, we find ourselves mired in the mathematics of probability...

And when it comes to mere statistical probability, you'll win with a Dow stock over a penny stock nine times out of ten. After all, we're talking about 30 of the most stable, well established companies on the market. The worst performer out of this group so far in 2007 is Microsoft, and it's lost only a little more than 3% of its value.

Back in Pennyland, stables of small stocks have already logged double-digit losses so far this year. Many of these losers are boondoggles and broken companies trying to stay alive-- companies that would never make it past a thoughtful selection process...

However, if your idea of an investment strategy is throwing darts at the thousands of small stocks on the market, the odds are decidedly against you.

That's why comparing the Dow Jones Industrials to the gigantic world of penny stocks is bunk. Throw your darts at the DJI and you could lose 3%. Do the same with small stocks and you could lose your shirt.

It's simple to take the two groups separately, pull together averages and call it a day. But - unless you're heavily into index funds - this is probably not a reflection of how you are selecting stocks.

When you narrow your focus to the universe of smaller stocks, then narrow it again to your specific investment parameters, your chances of seeing the biggest possible gains improve drastically. It's that simple.

Sincerely,

P.S. At Penny Stock Fortunes Headquarters in Baltimore, we're looking for the select few small companies that could change the way the world does business. It's as simple as that.

The new PSF is firing on all cylinders right now and the recommendations are plentiful. In fact, all eight stocks we've covered so far are near recommended buying ranges. That's four CXS selections and four bonus picks from our brand new special report.

It's a diverse bunch, complete with a defense contractor, an energy company, a software provider, a biotechnology firm, and more...

Get the whole story by checking out the special report here:

Ignored Stocks Soar
http://www.isecureonline.com/Reports/PSF/EPSFH240

Feb 21, 2007
Gunner
for The Daily Reckoning

Former beat reporter Greg Guenthner uses his newsroom experience to dig up the hard-to-find headlines that could lead to big gains for your penny stock portfolio. After leaving the newspaper industry, Greg decided to dedicate his career to researching the most promising small public companies in the world.

In addition to his work with Penny Stock Fortunes, Greg is also the managing editor for The Sleuth. The free daily e-letter dedicated offers insight into strategies, news, technology and trends of the small-cap market. In his Sleuth columns, Greg has written extensively on everything from alternative energy to biotechnology.

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