The Little Book of Big Profits from Small Stocks, + Website

1. Low-priced stocks under $10 offer untapped potential for significant returns

It's simply easier for a $10 stock to go to $15 than a $50 stock to go to $100.

Untapped potential. Low-priced stocks are often overlooked by Wall Street and institutional investors, creating opportunities for individual investors. Many mutual funds and pension funds are prohibited from owning stocks under $10, leaving this sector relatively unexplored. This aversion creates a fertile hunting ground for savvy investors to find undervalued companies with significant upside potential.

Price movement dynamics. Low-priced stocks can experience more dramatic price movements due to supply and demand factors. When institutional investors eventually discover these stocks, the influx of capital can lead to rapid price appreciation. This "snowball effect" can result in outsized returns for early investors who identified the potential before the broader market.

Examples of success. The book cites numerous examples of low-priced stocks that have delivered exceptional returns, such as:

• Darling International (DAR): Rose from under $5 to over $18 in about two years
• Priceline.com (PCLN): Increased from around $1 to over $500 in less than a decade
• Ford Motor Company (F): Rebounded from under $2 to over $18 in just a few years

2. Three categories of low-priced stocks: fallen angels, undiscovered growth, and bargain bin

Any ten-baggers you run across along the way will just be icing on the cake!

Fallen angels. These are formerly high-flying stocks that have fallen out of favor. Key questions to ask:

• What went wrong?
• Can it be fixed?
  Fallen angels often have strong brand recognition and valuable assets, making them prime candidates for turnarounds.

Undiscovered growth. These companies are experiencing steady growth but remain under the radar. Look for:

• Companies in unsexy or overlooked industries
• Steady revenue and earnings growth over 5+ years
• Low debt-to-equity ratios
• Insider ownership of 10% or more

Bargain bin. These stocks trade below their tangible book value. Screening criteria:

• Price-to-book ratio below 1
• Debt-to-equity ratio below 0.3
• Positive earnings (P/E ratio > 1)
  Focus on companies with easily valued assets like cash, real estate, or commodities.

3. Biotech and global stocks are fertile grounds for low-priced opportunities

Cell signaling is thought by many researchers to be a potential breakthrough in understanding and fighting cancer.

Biotech potential. The biotech sector is ripe with low-priced opportunities due to:

• Rapid technological advancements
• Increasing healthcare needs, especially in areas like cancer treatment
• Partnerships between small biotech firms and large pharmaceutical companies

Key factors to consider in biotech stocks:

• Stage of drug development (Phase I, II, or III trials)
• Strength of partnerships with larger companies
• Potential market size for the drug or treatment

Global growth stories. Emerging markets offer numerous low-priced stock opportunities:

• Infrastructure development (e.g., Cemex in construction materials)
• Telecommunications expansion (e.g., Telecom New Zealand)
• Consumer goods for growing middle classes

Look for companies benefiting from long-term trends in developing economies, such as urbanization, increasing consumer spending, and technological adoption.

4. Traditional valuation metrics don't apply to low-priced stocks

We are looking for directional trends rather than actual numbers.

Beyond P/E ratios. Traditional valuation metrics like price-to-earnings (P/E) ratios or price-to-earnings growth (PEG) ratios often fail to capture the potential of low-priced stocks. These companies may have temporarily depressed earnings or be in the midst of a turnaround, making historical ratios less relevant.

Focus on improvement. Instead of absolute numbers, look for signs of improvement in key metrics:

• Revenue growth
• Margin expansion
• Debt reduction
• Increasing return on equity (ROE)

Balance sheet strength. Pay close attention to the balance sheet, looking for:

• Debt-to-total-capitalization ratio of 50% or less
• Sufficient cash to fund operations and growth
• Valuable assets that may be underappreciated by the market

5. Thorough research and networking are crucial for identifying breakout candidates

You may not be aware of it, but you probably have the resources and network to help you explore under-the-radar stocks.

Key research sources:

• SEC filings (10-K and 10-Q reports)
• Company investor relations websites
• Industry trade publications
• Analyst reports (accessible through many online brokers)

Leverage your network. Tap into your personal and professional connections for insights:

• Friends in various industries
• Local business owners
• Professionals (doctors, lawyers, etc.)
• Community leaders

On-the-ground research. Pay attention to trends in your daily life:

• Products gaining popularity
• Changes in consumer behavior
• New technologies or services gaining traction

By combining formal research with real-world observations and networking, investors can gain a comprehensive understanding of potential breakout stocks before they hit the mainstream.

6. Timing is key: Know when to buy, hold, and sell low-priced stocks

When everybody loves it, the question becomes who is left to buy it?

Buying opportunities:

• During market-wide sell-offs or sector-specific downturns
• When a stock is unfairly punished for short-term issues
• After a period of price consolidation with improving fundamentals

Holding criteria:

• Continued improvement in key financial metrics
• Increasing trading volume and new price highs
• Absence of major red flags (e.g., insider selling, accounting irregularities)

Selling signals:

• Achievement of your price target or valuation goals
• Deterioration in fundamental business drivers
• Excessive hype or universal analyst buy recommendations
• Acquisition by another company (often at a premium)

Consider scaling out of positions as they appreciate, taking partial profits while maintaining exposure to further upside potential.

7. Beware of fraud and manipulation in the low-priced stock market

If you are getting promotions from some one you never heard of or some distinguished-sounding research firm providing information on wonderful opportunities to make millions of dollars off the next big thing, just hit delete.

Common scams. Be aware of fraudulent schemes in the low-priced stock market:

• Pump and dump schemes
• Boiler room operations
• Internet-based stock promotions

Red flags:

• Unsolicited stock recommendations
• Promises of guaranteed or extraordinary returns
• Pressure to act quickly
• Companies with no real business or assets

Protection strategies:

• Conduct thorough, independent research
• Verify information from multiple sources
• Be skeptical of "too good to be true" opportunities
• Use reputable brokers and trading platforms

By staying vigilant and focusing on legitimate companies with real businesses and improving fundamentals, investors can minimize their exposure to fraud while capitalizing on the significant potential of low-priced stocks.

Last updated: November 19, 2024