Roadrunner Picks: A Trio of Small-Caps

10/07/2013 10:00 am EST

Focus: STOCKS

James Fink

Editor, Jim Fink's Options for Income and Stocks to Watch

Jim Fink, editor of Roadrunner Stocks, highlights a trio of small cap favorites; he also explains a conservative income strategy using put spreads.

Steve Halpern: We are here today with Jim Fink, Editor of Roadrunner Stocks. How are you doing, Jim?

Jim Fink: I'm great. Thanks for having me.

Steve Halpern: First, let's start with your stock market outlook. You recently pointed out that the current bull market is now the sixth longest of the past 113 years. Do you expect this trend to continue, or is it time for a correction?

Jim Fink: Well, sixth longest means there are five longer, and so, it definitely can go longer. I think it will go longer in the intermediate term, but in the short-term, I think a correction is becoming more likely.

It just seems that with the troubles in Washington, with the government shutdown, the October 17 deadline for a debt ceiling extension, there's a lot of potential conflict coming down the line over the next two to four weeks.

So, I'd be very careful over the next month or so, but after that, I think we're going to start moving higher again, just because the market has recently hit a new all-time high just earlier, in the month of September. So, short-term, dicey, longer term, bullish.

Steve Halpern: Now, you're particularly optimistic on the long-term outlook for small-cap stocks. Why do you expect small-caps to outperform looking out over the longer term?

Jim Fink: Well, just look at history. I mean over the 80 year period that we've just gone through; small-caps have outperformed large-caps significantly.

We've got small-cap value that has increased at a 14.1% annualized rate, whereas large-caps have lagged behind by at least three percentage points, so just history tells you that small-caps will do well.

In the shorter term, small-caps also should do well simply because we're just recently starting to see an economic revival. We've got Europe improving, we've got the US definitely having some mixed signals, but overall, with the Federal Reserve thinking of tapering-they're thinking of tapering, because the economy is gradually strengthening.

We've got a very strong housing market, a very strong auto market that I think is going to expand into other sectors, and small-cap stocks are especially sensitive to economic growth, so if economic growth is going to increase, small-caps will take the lead.

We also have the fact that, historically, small-caps have performed much better when interest rates are rising. That's certainly happening now, because that's another indication of economic strengthening, and the fact that a Democrat is a president in the White House.

Politics does play a role. Small-caps have outperformed when Democrats control the White House and that's going to be the case for at least the next three years.

Steve Halpern: Now what industry sectors do you find particularly attractive right now, and would you be kind enough to highlight some stock ideas within those sectors?

Jim Fink: Sure, given my theme that the economy is strengthening, I want to be in the economic sectors that are more economically sensitive, so that would translate into consumer discretionary type stocks.

That would also include technology stocks and industrial stocks; all three of those economic sectors do better when the economy is strengthening, so one such name, I really like housing right now. It's been strong for the past, you know, month or-it's been strong for over a year now, but I think there's more to go with that.

One small-cap name in the housing sector is TRI Pointe Homes. That's a New York Stock Exchange stock, ticker symbol (TPH). It's controlled by Barry Sternlicht, who's a very wildly successful real estate entrepreneur.

Right in the heart of the housing crisis in 2010, Sternlicht Starwood Capital made $150 million investment in TRI Pointe to help it buy land in California for home building. Sternlicht is now the TRI Pointe's chairman and I think California's real estate is going to continue to improve.

A second stock I like right now is Blackhawk Network Holdings. It helps Americans with gift cards, which is a growing trend instead of having to think of what gift to get people, you can just give them a gift card and the recipient has the control over what to actually buy.

Grocery store chain Safeway established Blackhawk back in 2001 and the business has grown in leaps and bounds in tandem with the gift card craze and they just spun off their Blackhawk Network holdings over the past few months to the NASDAQ stock, ticker symbol (HAWK).

And lastly I'll go into healthcare, which is kind of a growth cyclical type name. It's partially defensive, partially growth. I think the more growth-oriented section of healthcare would be biotech, and right now, a very promising biotech stock is Enanta Pharmaceuticals. That's a NASDAQ stock; ticker symbol (ENTA).

Biotech stocks typically burn through cash and suffer losses as they develop their products, but Enanta is one of the few biotech stocks that actually is earning money in cash flow positive right now. It specializes in treatments for hepatitis C, a virus that kills thousands of people each year and I think it has tremendous potential.

Steve Halpern: Now in addition to Roadrunner Stocks, you're also the Editor of a service called Jim Fink's Options for Income. Could you briefly tell us about the service, and perhaps highlight an option strategy, so the listeners can understand what you try to address in this newsletter?

Jim Fink: Sure, Options for Income is a conservative options service. There are a lot of very aggressive ones out there, but I like to focus on conservative strategies that bring in monthly income. The primary strategy in my Options for Income service are selling put spreads.

Put spreads are where you sell one put option, slightly below a stock price, and buy another put option even further below the stock price as insurance. It is a very limited risk strategy; the risk is limited to the difference between the put strikes, and yet, it offers a very high rate of return.

Typically, these put spreads that I recommend have returns of at least 20%, sometimes 30% to 40% and if you do enough of these put spreads, you're well-diversified, and yet, you have very low risk, and yet, very high return potential.

Another reason they're conservative is because I pick put strikes that are below the current stock price, so the stock can actually decline a moderate amount and these put spreads will still expire worthless for maximum profit, so you don't have to wait for the stock to actually go up to make money.

One trade, as an example, that I like right now is Procter & Gamble (PG). It's a very stable stock. It's not going to go up much, but it's not going to go down much either, which is perfect for put spreads, and a good trade right now would be selling the December 75 put, buying the December 70 put for a net credit of $1.45.

The rate of return of that spread is over 25% and with Procter & Gamble currently trading around 76, the stock can actually decline by a dollar and this put spread will still expire worthless for maximum profit.

Steve Halpern: Well, we appreciate you sharing your insights today and thanks for joining us.

Jim Fink: It's been my pleasure. Thank you.

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