These Stocks Will Burn You

These Stocks Will Burn You
By Rex Moore December 27, 2008 Comments (16)

In his article "The Market's 10 Best Stocks," my colleague Tim Hanson pointed out the benefits of searching for the next multibagger success stories among the smallest of companies.
And I agree with him: The best stocks of the next decade will not be huge companies. Why not? This chart should explain. Look how large each of these businesses would become if they increased just 10 times in value over the next decade.

Company
Current Market Cap (billions)....10-Bagger Market Cap (trillions)
General Electric (NYSE: GE)....$164....$1.6
Citigroup (NYSE: C)....$36....$0.4
Bank of America (NYSE: BAC)....$64....$0.6
Pfizer (NYSE: PFE)....$115....$1.2
Intel (Nasdaq: INTC)....$78....$0.8
Google (Nasdaq: GOOG)....$94....$0.9
Cisco Systems (Nasdaq: CSCO)....$95....$1.0

While it's certainly possible, we probably won't have a trillion-dollar company by 2018 -- much less see any of these large caps turn into 20- or 30-baggers. So we can count the giants in that chart out of the running for best performer of the next decade.

Instead, the greatest chance for the greatest gains comes from the smallest of companies, like the Tiny Gems that the Motley Fool Hidden Gems team follow. These half-pint companies are capitalized at less than $200 million, and there's plenty of room for them to grow before they run into the headwinds of large numbers and their prospects become more limited.
But before you take a free trial and jump headfirst into the micro-cap waters, listen up: This ride is not for everybody.

Buckle up

With great potential reward comes great risk. Just as a tiny company has the greatest chance at outlandish gains, it also has the best chance of going belly up. Bankrupt. Gone ... along with your money. And the volatility along the way to greatness or the graveyard may give you whiplash.
Thus, these Tiny Gems are best suited for risk-tolerant investors with a long-term outlook.
That said, two things can greatly reduce the chance that your portfolio will get torched by tanking Tinies:
1. Believe the balance sheet. This is where you can tell whether a company is in danger. Little cash and large amounts of debt are a big warning sign, especially for businesses not yet turning a profit. Go back through the past several balance sheets. Is the company burning through cash? How fast? My advice: Stick to profitable companies with cash-to-debt ratios of at least 1.5.
2. Buy a "basket" of these micro caps. In other words, allocate the amount of funds you normally would for one stock to several of the Tinies -- four or five, for example. That way, you're giving yourself more of a chance at finding at least one huge gainer, which will more than make up for it if one or two of the others lose most of their value.


Rex Moore helps the team pan for micro caps and is an analyst for Stock Advisor. He owns no companies mentioned in this article. The Motley Fool owns shares of Pfizer, as well as shares and covered calls of Intel. Bank of America and Pfizer are Motley Fool Income Investor recommendations. Pfizer and Intel are Motley Fool Inside Value recommendations. Google is a Rule Breakers selection. The Motley Fool is investors helping investors.
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