Take The Long View on Small Stocks

06/17/2011 9:30 am EST

Focus: STOCKS

Marc Gerstein

Editor, Forbes Low-Priced Stock Report

To realize the true value in low-priced stocks, you need to view them as investments, not trades, writes Marc Gerstein of the Forbes Low-Priced Stock Report.

It’s hard not to cringe, at least a little, when one hears somebody talking about the “long term” in connection with stock investing.

Sometimes, we get patently unrealistic rhetoric, such as the famous Warren Buffett quip about his favorite holding period being “forever.” Don’t take it literally. He sells.

At other times, it seems as if exaltation of the long term sounds more like a reluctance to admit a bad investment decision. Sometimes, though, we really do need to give an investment more time to work out, especially when we want to realize home-run potential from low-priced stocks.

There’s another, less pleasant but still important reason why we sometimes have to think long term. As much as we like to believe we’ve thoroughly analyzed a company, and understand where it’s going and how it’s going to get there, life has an incredible way of surprising us.

To put it mildly: Stuff happens. Sometimes, unexpected developments are positive.

But it’s the other kind, the negative surprises, that we need to really assess because those are the ones that send the stock down, sometimes sharply. Some negative events relate to factors beyond a company’s control, such as the economy. Others reflect company missteps.

We see time and again how quick investors are to sell when something negative happens, regardless of the cause. If subsequent events suggest that our fundamental assumption about a company isn’t working, either because it was wrong on day one or because of subsequent changes, we need to sell.

On the other hand, we have to remember that company executives and employees are every bit as human as we are. They slip from time to time just as we do. No business strategy can ever be expected to be implemented as smoothly as a PowerPoint presentation might lead one to expect.

Patience, rather than selling, is what we often need here.

NEXT: A Bank Stock With Legs

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A Bank Stock With Legs
Bank stocks have long scared me because reported earnings involve considerable management discretion when it comes to bad loans.

Case in point: Macatawa Bank (MCBC), which was profitable in the latest quarter because it reduced its loan-loss reserve by $1.45 million.

But this issue is present at all times with all banks—and if one is to ever invest in this area, I think it’s better do so now, with so much bad news already out there, with the stocks already beaten down, and with progress toward improvement evident.

Helped by reductions in staff and compensation, the shortfall fell between March 31 and December 31, 2010, from $43.2 million to $17.2 million. A pending equity offering (of up to 17.8 million shares at $2.30) should put MCBC over the top.

While it might be reasonable to await completion of the equity offering, on the whole, Macatawa Bank is a speculative buy.

The Smallest Stock Around...But it Won't Be Forever
Railroads in the 19th century, biotech in the ‘70s, computer technology in the ‘80s, Internet at the turn of the 21st century—investors have always loved seeing new businesses being invented, and, sadly, have often lost heavily trying to buy in at the ground floor.

The stories usually were sound, often even better than early expectations. But investors got hammered by impatience: Many bought in at hype-driven stock prices that failed to reflect the time it would take to progress from vision to commercial viability.

Low-priced stock investors, however, may have an edge. Often, these stocks don’t come under our radar until after bubbles burst and stocks plunge—and, ironically, enough time has passed to enable company fundamentals to start taking reasonable shape.

That’s where we are now with the latest story, nanotech, and Nanophase Technologies (NANX).

The company is presently debt free and does not anticipate a need to draw on the $1 million credit line put in place last September.

At 2.9, the price/sales ratio looks high (the chemical industry median is 1.22). But with products in an early ramp-up stage, the company should easily grow into the valuation, and then some.

Nanophase is a long-term buy.

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