(Taipan Publishing Group) – Gold, small caps and the U.S. dollar have had a stable three-way relationship for the better part of the 2009 rally. Now the three could be parting ways.

Dr. Marc Faber is one of the few market wise men whose thoughts are worth pondering. His monthly “Gloom, Boom & Doom Report” is always a good read. He is an active, Asia-based investor with decades of experience, hundreds of millions under management, and many prescient calls under his belt.

Faber has stated firmly and clearly what he thinks of the U.S. dollar. As you might expect, his opinion is not too flattering.

In the long run, Faber assigns the buck a value of “zero.” In the manner of all fiat currencies, America’s scrip is slowly being turned into toilet paper. The present cast of clowns in Washington seems bound and determined to accelerate this process as Wall Street cheers them on.

But that’s the long term, mind you. In the shorter term – i.e. for at least the next quarter or so – Faber is bullish on the buck. So bullish, in fact, that he is now on record as a buyer of $USD.

“As of today, I will be long in dollars,” Faber told Bloomberg last week. (Perhaps he is buying from my colleague Adam Lass, who professed on Thursday his intent to remain short.)

Continue reading Justice Litle on Taipan Daily.

I’m talking about organic light-emitting diodes, or OLEDs. OLED displays are taking off in a big way. These next-generation displays are perfect for the mobile phone and personal media device markets because they are thinner than traditional displays and produce sharper images.

OLED — and active-matrix OLED — technology has now reached its tipping point. Very soon, we will begin to see OLEDs used in a vast array of electronics, including small televisions, digital cameras, netbooks, phones — the list goes on and on.

The rise of the OLED display is similar to that of the flat-panel television. Once a novelty, flat-panel LCD and plasma televisions quickly became the industry standard as quality and production increased while prices fell. The “transition” from bulky tube televisions to sleek flat-panel displays took only a few short years.

Try walking into your neighborhood electronics store today to browse the tube television selection. Be warned: You will be disappointed. Only a few models remain, and you can easily purchase a comparable flat-panel television for about the same price. And a flat panel can actually save you money, since it uses less power than a standard TV. Yes, it seems that the tube television is going the way of the VCR. It won’t be long before they’re only available at yard sales and antique stores.

OLED Growth: The Story Is in the Numbers

Experts from world mobile display sector leader Samsung Mobile Display are banking on OLED screen use in mobile phones to “grow significantly.” And with overall smartphone use also growing dramatically, we have before us a unique opportunity in the OLED market.

The Samsung venture expects the global smartphone market to grow to 500 million units by 2012, making up almost 30% of the industry. To put this in perspective, consumers are using 170 million smartphones right now.

Better phone technology means better displays. Samsung predicts OLED screens will be used in half of these new phones over the next five years. That’s hundreds of millions of units…

Overall, the OLED display market will grow to $6.2 billion, according to DisplaySearch forecasts. Last year, the total OLED market was worth an estimated $600,000. As you can see, we are looking at exponential growth, with the mobile phone market leading the charge.

As the technology continues to improve, we will begin to see even larger OLED displays. LG Electronics and Sony (NYSE:SNE) are each planning on releasing 15-inch and bigger OLED display televisions by the end of this year, according to DisplaySearch, with OLED netbooks and larger televisions showing up by the end of 2010.

Obviously, LG and Samsung are the big players in this market. But there are a couple of small-caps that have also found success developing OLED technologies. A good place to start looking would be Universal Display Corp. (NASDAQ: PANL). While the company is not yet profitable, it does have a promising patent portfolio that includes phosphorescent OLED technology.

Best,
Greg Guenthner

Source: OLED: The Next High-Tech Profit Opportunity

With the small-cap research tool I’m about to show you, you’re well on your way to seeing how the market moves ahead of the herd.

Here’s everything you need to know…

A while back, I wrote to you about our Small-Cap Recovery Index. The index is composed of fundamental data from 100 small-cap stocks, as well as economic factors like unemployment and personal savings rate.

It’s designed to give us a glimpse at signs of recovery for the stock market.

While the market has rebounded in a big way since it bottomed in March, many investors are concerned that stock prices are already getting out of whack. But we’ve designed the Small-Cap Recovery Index to go beyond share prices.

Unlike major indexes — like the S&P 500 or small-cap Russell 2000 — ours isn’t a typical stock index. While hundreds of stocks are included in the index, stock prices actually have a relatively small effect on its daily movement. The majority of the index is based on the latest available fundamental performance.

But while gauging how “healthy” the market is can be very valuable, the Small-Cap Recovery Index provides us with considerably more data. In fact, as we continue to watch the index, we hope to use the information it provides to not only peg where the broad market is headed, but which industries hold the keys to growth.

We can accomplish this thanks to the predictive power of small-cap stocks. You see, historically, penny stocks lead the stock market out of recession. “From 1943–2007, according to one analyst, small companies outperformed large companies by more than 50 percentage points in the three years following a recession, including the one following 2001,” explained Ken Kurson in an article published on Esquire.com a few months back.

By monitoring how small caps perform fundamentally and technically, we can essentially predict where more major indexes — the S&P 500, for instance — are headed.

Now, 12 weeks into collecting and analyzing our data, we’ve already caught some indications that the index is doing its job. More on that in a bit…

A Look at the Small-Cap Market

The chart above shows the Small-Cap Recovery Index for the last 12 weeks. The index, which is calculated daily after the market close, is based on a 100 scale — its current value of 107.4 means that the Small-Cap Recovery Index has gained 7.4% since we began tracking it.

While a high number for the S&P 500, which just measures share prices, could suggest that stocks are overvalued, when it comes to the Small-Cap Recovery Index, bigger is definitely better. That’s because a higher number means that the small caps that make up our index are performing well for investors and — more importantly in this environment — performing well from a financial and economic perspective.

In the past couple of months, the index has seen its value increase materially, which is a very good thing. But while the SCRI’s value gives us a good idea of how small caps are performing, it doesn’t do a very good job of actually predicting where the markets will move next. That’s where the oscillator comes in…

The Small-Cap Recovery Index Oscillator

The Small-Cap Recovery Index Oscillator, which is based on the index itself, measures the divergence between the performance of the Small-Cap Recovery Index and the S&P 500.

While that sounds pretty complicated, it’s actually a very simple concept. The rationale is that the S&P 500, which is a pretty good indicator of the market itself, shouldn’t move significantly more or less than our Small-Cap Recovery Index. And because fundamental data that move ahead of the market — like sales and unemployment — are factored into our index, our index should set the direction of market movements first.

When things are stable, the oscillator should sit around 0 — meaning that there isn’t a major difference between our index and the S&P. But when it moves very high or low, it sends a signal that the S&P, which doesn’t have fundamental economic data to keep it grounded, should move back in a direction to push the oscillator back down.

We’ve actually come up with a math-based methodology to place bets on the market using the data that the oscillator spits out.

And while the specifics are too rigorous to detail here, we’ve determined that if you had used those rules to invest in the ProShares Ultra S&P 500 ETF (NYSEArca: SSO) or the ProShares UltraShort S&P500 ETF (NYSEArca: SDS), depending on the buy or sell signal, you would have made 36.03% in just six weeks.

That’s an annualized gain of 312.26%!

And right now, with the oscillator (the blue line in the graph below) high, it suggests that the market’s buying frenzy is coming to an end. That’s not to say that the oscillator can’t be wrong — we’re still in the early stages of collecting data and testing its accuracy.

So what’s the SCRI Oscillator telling us right now?

While it’s good that the SCRI has increased in the last 12 weeks, a quick look at the oscillator shows us that the S&P 500 has increased much more quickly — that’s actually a bad thing for the market because it means that investors have overvalued the S&P against the fundamentals of the market.

And already, we’re seeing the S&P 500 start to decline to fall back in line with the Small-Cap Recovery Index. Unless big stocks improve their fundamentals enough to match the small-caps, it’s time to expect a tumble in the S&P back to SCRI levels. We still have considerable data to collect before we begin to use SCRI data in our stock picking methodology, but right now, it’s clear that the index could soon become a very powerful tool in our investment arsenal.

Cheers,
Jonas Elmerraji

Source: The Only Tool You Need to Predict the Market’s Moves

I’m not someone who needs a pat on the back to feel good about my work.. However, even I’ll admit it’s nice to have my judgment validated – especially when it comes from a well-respected source like Barron’s.

That’s what happened last Saturday when the 88-year publication published a story about the small-cap healthcare stock Electro-Optical Sciences (Nasdaq: MELA). As a result, shares soared 19% on Monday.

What’s more, the author, Neil Martin, expects the stock to tack on an additional 50%, as the company’s melanoma detection device is expected to gain FDA approval and become a big hit with physicians and patients.

I couldn’t agree more. In fact, I came to the same conclusion about 18 months ago when I first recommended the stock to subscribers of my small-cap healthcare service Access. Most subscribers got in at $5.50 or below. Some even reported buying in the $3 range.

Today, the stock is trading around $9.50.

Question is: How do you find these small-cap winners – particularly in the minefield-laden healthcare and biotech sectors? Here’s the tried-and-tested method I use…

Unearthing Small-Cap Healthcare Stocks Isn’t Easy…

Unearthing mega winning small-cap healthcare stocks isn’t easy. It’s certainly not a case of just looking at a chart or some magical signal that tells me it’s time to get in. For me, it’s a multi-level process that is fairly time-intensive.

You see, I learned how to analyze stocks from two of the greatest contrarian analysts on Wall Street. Guys who demanded the best and didn’t accept anything less.

First, I had to pass rigorous exams. Then it was trial by fire. I had to sell my idea to my boss before I was even allowed to begin conducting formal research on company time.

If it wasn’t sufficiently contrarian or well below Wall Street’s radar, he’d shoot me down.

And believe me, I was shot down more times than a drunken frat boy in a room full of supermodels.

But the rejection served me well. It forced me to create a stock research methodology that would not only satisfy my boss, but also prove profitable for folks who took my advice. It’s the same process I use today to pick stocks for Access and The Xcelerated Profits Report.

It’s called the F.I.R.S.T. system. Here’s how it works…

Breaking Down the 5-Step Process of the F.I.R.S.T. System

F.I.R.S.T. is an acronym for a five-step process that ensures I cover absolutely everything before I get a recommendation out to the public.

• Financials: This is the first step. I check everything from how much cash a company has at the moment, to how much it will need in order to fund its pipeline products and operations. Before a company is even worthy of making it to the next steps, it has to pass my financial model, which estimates revenue, earnings, market size, market share, margins and a host of other variables to determine whether the potential growth will be good enough.
• Interviews: If the numbers tell me it’s a good opportunity, I move onto the interview phase. But I don’t just talk to the company’s CEO and CFO, I talk to doctors who are using the product, plus others who aren’t. I get on the phone with specialists in the field, independent experts, the warehouse foreman – anyone who can give me on-the-ground insight into the company’s performance and prospects.
• Research: If I still like what I hear, then I dig into the hardcore step – roll up your sleeves, burn the midnight oil research. I read scientific papers, journals, news articles and even blogs to establish whether the company’s products will be successful.
• Safety: Both from an investment and human interest standpoint, this is the most important step. Drug/device safety is critical. Even when drugs have successfully treated diseases, I’ve seen the FDA reject them because they couldn’t be proved safe enough. The FDA is very conservative right now and we don’t want to be in any positions where there is even a question of safety, no matter how well the drug works.
• Timing: From an investment perspective, once I know that I like a company, all that remains is a reason to invest now. I search for the catalysts that will move the stock in the next six to 12 months. At the moment, I’ve got plenty of companies on the backburner because even though I like them, investing in the shares now would be dead money for another year.

A Deeply Contrarian Investing Approach Is Critical

As I noted above, my investing experience is rooted in a deeply contrarian approach. Finding stocks that you won’t hear about anywhere else is a critical aspect of my stockpicking methodology.

For example, virtually no one was talking about MELA last year. I’ve recommended several other stocks that are also practically unknown to Wall Street. This includes a swine flu play, a bioterror therapeutic stock and two little device companies that are poised to take market share from the big boys – which should result in significant earnings growth or a buyout (or perhaps both).

When it comes to investing in small-cap stocks, conducting thorough research becomes even more critical. You really need to roll up your sleeves and put in the work because in most cases, you won’t read about them in Barron’s, see them on CNBC, or hear about them from an analyst until much later in the company’s development. And by the time everyone else notices them, we’re already sitting on nice gains.

Good investing,

Marc Lichtenfeld

Source: How to Unearth Explosive Small-Cap HealthCare Stocks

For a bunch of financial writers, we sure do a lot of talking. There is no debating we have a lot of interesting discussions around the TFN office. Yesterday we got into an in-depth conversation about penny stock investing.

The question: what does the perfect small cap look like?

Of course, each of us had differing opinions based on our own theories and experiences, but we came to one obvious conclusion. Give us a small cap that has the books of a Blue Chip and we will show you a winning pick.

As if it was some sort of divine intervention, our conclusion was proven to be deadly accurate this morning.

When I initially recommended SpongeTech (OTC BB:SPNG) to Hot Stock Confidential subscribers on August 13, I said, “The company’s balance sheet reads more like a blue chip than a speculative penny pick.”

It’s true. SpongeTech was highly undervalued. It was buying back its shares and is growing like the national debt.

The recommendation was only made two weeks ago, but already it has paid off. I advised readers to sell half of their positions for gains of 30% today. By locking in at today’s price, we can afford to ride out any future volatility.

Room for more

Almost instantly after sending out the sell alert, another “small-cap Blue Chip” popped up on my screen.

The headline from the Associated Press reads, “Kewaunee Scientific raises dividend to 10 cents.”

My first thought… who in the world can raise their dividend in this economy?

For any investor who has ever studied signaling theory, this is the ultimate buy signal from the company’s management. It shows that Kewaunee’s (NASDAQ:KEQU) top brass is confident growth is going to exceed shareholder expectations organically.

Investors rewarded the company by increasing its share price by as much as 8% during the session.

Of course, digging through the company’s books, it is obvious this company is a Blue Chip in a small-cap shell.

With a market value of just $33 million, many of this company’s brethren barely have revenues worth noting. Kewaunee flexed its muscle by sporting a top line of $104 million last year. Best of all, the company turned the sales into a net profit of $4.2 million.

A 4% margin is not worth shouting about, but it sure beats what Ford (NYSE:F), Boeing (NYSE:BA) or Hone Depot (NYSE:HD) did during the same period.

Now, with a market cap of $33 million and $4 million in earnings, we get a price/earnings (P/E) ratio of 8.25.

Home Depot’s ratio stands at 20. Boeing comes in at 15. And Ford, well, it may be a few years until it finds a positive figure for the ratio’s denominator.

Of course, with any small cap, liquidity is a major risk factor. With $25 million in debt, investors should certainly watch Kewaunee’s leverage. But it is nothing worth crossing this one of your buying list for.

After all, aren’t liquidity concerns an issue at almost every Blue Chip these days? The Dow was built (and crashed) on debt.

As a manufacturer of laboratory equipment (cabinets, vent hoods and work surfaces) Kewaunee is in a strong position to take advantage of Washington’s trillion-dollar spending spree. As the biotech industry continues to grow and as more and more high-tech school labs are built, Kewaunee’s phone is going to be ringing a lot.

I am not saying to buy shares of the company right this instant – prices have risen a lot of the last six months – but it is worthy of your watch list.

I know it is at the top of mine. Our subscribers may be reading more about this winner in the months ahead.

Source: A Small-Cap Blue Chip

My neighbor owns a bar. He has twenty acres, half a dozen horses, a brand new truck, a house with two kitchens and is in the midst of putting a fancy, automated gate across his long, winding driveway.

His success is proof that Americans drink in good times and in bad times.

While not all of us are willing to deal with the endless hassles and the lifestyle involved in running a bar, there are ways to take advantage of the nation’s unquenchable thirst.

If you are a small-cap investor, Craft Brewers Alliance (NASDAQ:HOOK) will certainly get your attention. Shares of the not-so-micro-brewer have surged over the last two days, climbing from below $2.75 to $3.80 at the moment. In March, you could have gotten in under a buck.

What’s behind the sudden jump? A stellar earnings report.

Earlier this month, Craft Brewers announced it recorded just over $66 million in revenues during the first half of the year. It translated the sales into a profit of $664,000. Not bad considering the company recorded revenue of $22.4 million during the same period last year.

Obviously a nasty recession has not kept too many folks away from bellying up to the bar.

Any chance of a hangover?

The upside of getting in on a quickly growing brewer are fairly obvious. The growth potential is through the roof. Beer is nearly recession proof. And barriers to entry are large enough to keep the competition at bay.

But what about the downside? What do investors need to know that may not jump out at them right away?

First thought… commodity prices.

Brewing high-quality beer takes a big pile of high-quality raw materials. As energy and commodity prices climb higher and higher, this will have a definite impact on margins.

Another margin-cutting factor is a major problem for almost all up-and-coming manufacturers. Finding the right fit between capacity and output is a difficult task. Many young firms find some cash, build a fancy factory and wait for the orders to fill the assembly line.

The problem with the sudden growth in capacity is if the orders do not come flying in right away, much of the capacity will sit idle. But the company still has to pay for it. For manufacturers with large seasonal fluctuations, this can become a major concern, crushing margins and straining liquidity ratios.

Dig through Craft Brewers’ latest 10-Q and you will see this phenomenon is already hampering margins.

Finally, micro-brews tend to remain popular as long as they are micro-brews. Once customers start viewing the company as just another “corporation,” the appeal dwindles.

That’s why Budweiser has never successfully entered the craft beer market. Drinkers won’t buy the brew no matter how good it tastes.

For Craft Brewers, the future is going to be challenging. But by maintaining a regional stance and watching the company’s capacity utilization, Craft Brewers will be able to continue its growth throughout the next five to ten years.

That means today’s shareholders are likely getting a bargain.

Source: Craft Brewers: Toasting Triple-Digit Gains

The investment world is splitting in half. Now, more than anytime in the last 18 months, the winners are diverging from the losers. No more does a single macroeconomic event steer the markets.

We are back to individual fundamentals and microeconomic themes. That means it is a stock-picker’s market.

Perfect evidence of this phenomenon comes from two companies with similar product offerings but widely divergent business models, GameStop (NYSE:GME) and Gravity (NASDAQ:GRVY).

Shares of GameStop are down by over 5% so far today as the Street digests the firm’s latest earnings figures.

With wary consumers unwilling to open their wallets, especially on non-essential items like video games, the company’s top line shrunk by 3.7% over the past three months.

The $1.74 billion in revenues translated into $38.7 million in second-quarter profits, a plunge of over 30% from the prior-year period. Making the figures appear even worse, same-store sales dropped by 14%.

The figures prove that growth was nowhere to be found, which is bad news as the company prepares to enter the critical shopping period that is the fourth quarter.

With chances of significant growth running slim, executives were forced to lower their earnings expectations for the remainder of the year. GameStop now estimates a full-year profit of $2.64 per share, down from its previous prediction of $2.93.

While GameStop may be representative of the nation’s consumer spending, it is not indicative of the kind of revenue-generating power held by some of the gaming industry’s strongest, leanest competitors.

When it comes to running a lean business, few can do it as well as the Asians, home of almost all modern efficiency practices.

While GameStop wonders where everybody went, a growing competitor, South Korea’s Global Gravity, is celebrating the fast-growth it has found in the online gaming sector.

Thanks to the drastically reduced costs and increased exposure of the Internet, Global Gravity is poised to take over as a planetary powerhouse in the gaming industry.

Size doesn’t matter

With its Ragnarok Online product soaring in popularity across the globe (it has strong exposure in 62 countries on five continents), Global Gravity shareholders are wondering what the future holds.

Today, they are getting a glimpse of the possibilities as shares of their company are surging ahead by more than 20%, thanks to a strong, intra-day volume spike.

The diverging pricing action between these competitors teaches us an important lesson. As I mentioned above, when the nation pulls out of a nasty recession, corporate fundamentals will become more and more important.

Margins, debt, free cash flow and market share will show the obvious difference between winners and losers.

We know consumers will not be dumping their savings accounts anytime soon. That means companies will be forced to stretch every dime of revenues as far as they possibly can.

Efficiency is not a wildly common concept here in the States. GameStop proves it. For companies based in Asia, however, it is not only a way of life, it is a means of survival.

Gravity may only have a market valuation of $69 million (compared to GameStop’s figure of $3.9 billion), but we all know it is not the size of your company that matters.

It is how you use it.

Source: International Small Caps: Size Doesn’t Matter

You see, as a small-cap investor, you’ve got very different concerns compared to those who only buy and sell blue chips. One of those concerns is order execution. And most likely, it’s something that you haven’t heard about anywhere else…

That’s because for the most part, order execution is a term that’s relegated to the big players – firms like Goldman Sachs and T. Rowe Price that have teams devoted solely to proper order execution. But penny stock investors have many of the same order execution concerns on tiny, thinly traded stocks that the big Wall Street firms do with companies like GE and Microsoft (NYSE:MSFT).

But before we get down to brass tacks, let’s take a look at what order execution means…

Order execution is the process that swings into action when you try to buy or sell a stock. When most investors place an order with their brokers, execution is nearly instant. But when small-caps are concerned, thin trading volume can play havoc with share prices and with your profit or loss.

It’s important to remember that as its name implies, the stock market is a market. That means that stocks move based on supply and demand, and not necessarily their intrinsic value. While that works well for heavily traded stocks like Exxon Mobil  (NYSE:XOM) or Wal-Mart (NYSE:WMT), where thousands of investors keep shares around their fair value by buying and selling millions of shares each day, some small-caps only trade a few hundred shares during any given trading session – some trade even less than that.

As a result, penny stock share prices can sometimes deviate pretty far from where they should be. And while that can provide prescient investors with a whole lot of profit potential, it can also be a big problem for those who don’t protect themselves.

Understanding Bid-Ask Spreads

Like mentioned before, stocks trade in a market. In markets, prices are set by the participants – in this case individual and institutional investors who buy and sell shares of stock. There are two pieces of price information for any stock: the bid, which represents how much investors are willing to pay for a stock, and the ask, which represents how much current shareholders are willing to sell for. When those two numbers intersect, a trade happens.

The bid and ask aren’t hypothetical numbers – they represent real outstanding orders.

For any stock, there’s a separation between the bid and the ask, knownas the spread. If someone’s willing to sell shares of Bank of America (NYSE: BAC) for $16.84 and another person’s wiling to buy shares for $16.83, your bid-ask spread is one cent. The spread is kept small by the large number of traders in the stock, who volley back and forth maintaining a tight range for BAC’s share price.

But for a stock that’s more thinly traded, spreads can be huge. That’s a big problem for small-cap investors because a spread that span’s 2% to 3% of a stock’s share price can essentially shear that kind of performance from their position from the get go.

And starting out 3% in the red from the second you buy shares of a stock isn’t a good deal…

When you’re missing out on 3% of every trade, that disadvantage begins to add up big time. But follow these three secrets, and you can ensure that you’re making out on your small-cap trades:

1. Love Liquidity

The best way to avoid being burned by a lack of liquidity is to only trade stocks that have enough trading activity to keep share prices in a reasonable range. And while that may sound limiting to some investors, the truth is that there are ample investing opportunities in small-caps that still see decent trading volume on the market.

As a general rule, if a stock doesn’t trade thousands of shares during any trading day, it’s best to keep your distance.

2. Use a Limit Order

Market orders are a bad idea for small-cap investors. That’s because they automatically execute at the price necessary to make a trade, meaning that every time you initiate a market order to buy shares of stock, you’re rising up to meet the price the seller wants. With huge spreads common in small-caps, market caps are a sure way to lose money from the get go. Instead, use a limit order.

Limit orders are essentially market orders that only execute below a certain price when you’re buying shares, or above a certain price when you’re selling. They’ll help ensure that your entries and exits are happening at prices you set, not the other party.

3. Beware of Promotions

Stock promotion is a popular way for small-cap companies to increase daily trading volume. The practice, which often employs dubious ethics, involves hiring firms that spread good news or sentiment about a tiny stock. But being on the wrong end of that strong sentiment can be a very bad thing. Since volume in small-caps is often so thin, the huge volume surges caused by stock promoters can sometimes move a stock’s share price by more than 20%.

To avoid getting into stocks that are being manipulated, check out promoters’ favorite places – investing message boards and press release websites – for over hyped language that goes beyond what one of the company’s shareholders would spout off. If you see the same language in multiple locations, chances are that a promotion is underway.

The stock market is a tricky enough place to operate. After all, there’s no way to guarantee that the next stock you pick will deliver 100% profits. And there’s no telling whether the company you just added to your portfolio is a sure thing. But even with all of that uncertainty, you don’t have to give away your gains before you place a trade. Now you’ve got three ways to make sure that order execution mistakes don’t squeeze your profits.

Cheers,
Jonas Elmerraji

Source: 3 Secrets to Profitable Small-Cap Order Execution

In the last two years, I’ve:

• Gone long the dollar when it was in the tank…
• Shorted oil near its peak…
• Shorted the big move to Treasuries on the heels of the credit crisis…
• And, most recently, shorted gold at $918 an ounce.

At the time of recommendation, each trade was extraordinarily unpopular, prompting some folks to flat out question my sanity. And yet, taking the dissenting opinion made money each time (the jury’s still out on the shorting gold trade.)

How’d I find the wherewithal – and nerve – to do it?

David Dreman – The Father of Contrarian Investing

I’ve been under the tutelage of David Dreman, known as “The Father of Contrarian Investing,” for many years.

Dreman literally wrote the book on contrarian investing. (If you don’t own a copy of his latest work – “Contrarian Investment Strategies: The Next Generation” – get one!)

In the book, he lays out his straightforward, time-tested investment philosophy to consistently outperform the markets: choose cheap investments that other investors hate.

Sounds too simple to be true, I know. But like any trading genius, Dreman’s track record underpins his investment philosophy…

• Since inception in 1988, his flagship large-cap value fund’s average annual return of 9.2% beats both the S&P 500 and Russell 1000 Value index by a full percentage point. His small-cap value fund has performed even better.
• Since inception in 2003, it has trounced the Russell 2000 Index (the benchmark for small-cap investments) and the S&P 500 index by more than seven percentage points.

Investing in Small Caps Predictions Ring True…

Recall, in January I predicted small cap investing would shine this year because they always do coming out of recessions. And this time has been no exception.

• From the March 9 bottom, small-cap stocks are up 50%, compared to 40% for large-caps stocks.
• And using history as our guide, we can expect more of the same ahead – small caps to trump the gains of their larger-cap peers for at least three more years.
• Thus, not capitalizing on this disparity would be foolish.
• Furthermore, the recent rally has increased stock valuations virtually across the board, so finding winning stocks will require increasingly more investment skill.

And that’s where Dreman comes in… No one on earth is better at unearthing small-cap value investments than he has been.

So how does he do it?

• First, he exploits the fact that the U.S. stocks with the lowest 20% of price-to-earnings ratios returned 16.8% per year from 1920 to 2004 – four percentage points better than the market as a whole. He buys nothing but such undervalued stocks.
• That said, he doesn’t just focus on the “cheapness” of a stock to determine its worthiness. “We don’t like dogs,” says Dreman, adding that, “All our stocks are financially strong, have high yields and earnings growth faster than the market.”
• He pays great attention to the stock filtering process, as well. Specifically, Dreman looks for companies with market caps between $300 million and $2.5 billion. Those are then screened based on their respective P/Es.
• Stocks with P/E ratios greater than the market get discarded, immediately (Dreman is innately opposed to paying a premium for growth). And the remaining companies (those with P/E ratios below the industry median) must possess an above average dividend yield, low leverage, low price-to-book and price-to-cash flow ratios, strong management teams and a catalyst that could spur future growth.

The result is typically three to four stocks in each industry group, with only one or two making the final cut.

Collectively, Dreman uses this investment process to construct a portfolio of 95 to 100 stocks from 50 different industry groups, with a 1% weighting to each. Such a small position size means that a single security can’t sour the overall portfolio performance. Which adds another layer of downside protection. (Deep-value stocks are inherently less risky than high-flying, high P/E growth stocks, anyway).

So clearly, Dreman does much more than simply buy small cap companies that investors have discarded, or ones in the midst of tough times. As he puts it, “We look for reasonably strong companies on the whole.”

But to really put his words into perspective, let’s consider a recent purchase…

Dreman Invests In Small-Caps With Aaron’s Inc.

Last year, Dreman added Aaron’s Inc. (NYSE: AAN) – a small-cap company that allows consumers to rent-to-own plasma TVs, household and office furniture and computers, without any credit checks.

Most investors looked at that business model, cringed and sold the company’s stock, causing it to lose 33% in 2007. After all, could you get any riskier than catering to consumers with poor or no credit during a credit crunch?

Dreman, of course, is too smart to fall for that. This guy can sniff out his prey from a mile away. He knew the current credit freeze was about to push previously credit-worthy buyers away from Best Buy and right through Aaron’s front doors. And with the stock trading at a historically low valuation below 11 times earnings, it was a no-brainer.

Sure enough, with an uptick in demand, Aaron’s earnings jumped a solid 19% last year alone.

And the stock defied the market, rallying 39% in 2008 while everything else took a bath. This year, it’s tacked on another 25%, thanks to a 55% jump in earnings in the first quarter.

Bottom line, small cap stocks can be some of the most profitable investments in any market. Should this market pull-back continue, consider this another great opportunity to pick up some attractive small caps.

But like Dreman, I recommend you stay away from dogs at any price.

Source: Investing in Small Caps: Why it Pays to be Contrarian

He says shares of one company – with $62 million in cash, no debt, and that pays out a 5.7% dividend yield – should see much higher share prices in the year ahead.

You don’t need a doctorate in economics from Stanford to realize that the economic climate is tough.

And while I write about financial issues every day, looking for bright spots and profitable opportunities, I have to admit that even I was shocked by what I saw last night…

Having packed up the family for a trip to the local mall, we arrived to find the place like something out of the Wild West. As in a ghost town. It was eerie how empty the place was.

At one point, I thought I saw tumbleweeds rolling out of Walden Books, blowing through the food court, and stopping at the remnants of a shuttered Z Gallerie.

There were only a handful of people in sight at any one time. Stores sat empty, with neatly arranged merchandise untouched as bored clerks read a romance novel, or sent text messages.

And today’s latest data reinforced the sad state of the economy…

Not So Much Riding To The Rescue… But Sauntering

According to government statistics, the number of newly laid off workers seeking job benefits rose to 626,000 last week, up from 591,000 the week before. That’s the highest level in nearly 27 years.

Roughly 6.5 million people are currently receiving unemployment benefits. And of course, that figure doesn’t count people who are no longer receiving benefits, or those who are under-employed.

In my last column I wrote about the lack of bipartisan cooperation to pass a stimulus package. But today’s jobless data could well be the catalyst that has forced the two parties to finally get together and pass some legislation – albeit a scaled-back version.

Word has it that the Obama administration has rejigged the aid package for the financial sector one that includes a so-called “bad bank” concept – and is set to announce the plan on Monday.

This could mean one thing for investors…

Beware The Teasing Bear

From a stock market perspective, this could be the driver of a short-term bear market rally. Great news, right?

My advice is that if you want to trade that rally, be my guest. But as prices go higher, be careful not to get sucked in and move much of the cash you might have kept safely on the sidelines into the market.

Bear market rallies can be quick and powerful. And as assets rise, it’s easy to think you’re missing the new bull. But we’re not out of this mess yet, and the markets will likely head lower before carving out a real bottom.

In fact, I expect the S&P 500 to trade in the 600s before this is over.

Profit From A Cliché… A Quick Three-Step Checklist To Investing In This Market

“It’s a stock picker’s market.”

This is a worn out cliché, but fitting for the current market. Simply put, it means there will be stocks that succeed despite the lousy economy and bear market. Here’s a quick three-step checklist of the main features you want to look for when picking stocks at the moment…

o Select stocks with healthy balance sheets. That means lots of cash and little or no debt. The last thing you want to worry about on top of everything else is whether or not your chosen companies will keep their doors open.
o Invest in companies that boast positive cash flow and run efficient operations.
o Lastly, a dividend yield is very desirable in this environment as it gives you a cushion against any declines.

Look To Small Caps And Find Your Own Stimulus

Another good historical fact to keep in mind throughout this downturn is that when the market stabilizes, it’s usually small-cap stocks that lead it higher again.

One stock to consider, using the three-step checklist above, is Electro Rent Corp. (Nasdaq: ELRC). The company rents, leases and sells electronic test and measurement equipment such as signal generators and spectrum analyzers.

The company has $62 million in cash, no debt, and trades for just 1.1 times its book value. It pays a juicy dividend yield of 5.7% and should be able to maintain it, given that earnings are expected to grow in fiscal 2009 and 2010.

So don’t wait for (or bank on) Washington to bail us out of this mess. Even as the market stumbles along, companies like Electro Rent (and others) that are still able to grow their earnings and maintain healthy balance sheets should give investors their own personal economic stimulus package.  And then maybe the malls won’t be quite so empty.

Hoping your longs go up and your shorts go down.

Marc Lichtenfeld

Source: The Current Economic Climate: A 3-Step Market Investing Checklist