Sometimes the best place to find value is where no one else is looking.
There are some that would argue that equities exist in conditions too close to a perfect market for anyone to consistently beat the major indices while picking stocks. In short, whatever information is available is so widely available that the market factors it into share prices almost instantaneously. With analysts everywhere pouring over data for every member of the S&P every day, how is a self-directed investor supposed to get a leg up?
Well, for James O'Shaugnessy, the answer was simple: look where others aren't looking. The micro-cap market, stocks with market caps of less than $300 million, was too large and too varied, he figured, for any of the major analysts to cover it completely. As such, the market continued to offer real opportunities to get ahead by identifying those stocks headed for bigger and better things before anyone else.
James P. O'Shaughnessy originally hails from St. Paul, MN, born there in 1960. It was there that O'Shaugnessy first discovered his love for investing and the stock market, beginning to track the characteristics common to the 30 companies on the Dow Jones Industrial Average at a very young age. After studying at Georgetown, he would get a B.A. in economics at the University of Minnesota and starting work at a venture capital firm.
His love for quantitative analysis eventually led to him starting his own capital management firm in 1988 and went on to great success. He wrote successful tomes on investing like What Works on Wall Street, How to Retire Rich, and Predicting the Markets of Tomorrow, and he created successful mutual funds made available to the public through the Royal Bank of Canada (RY) .
Tiny Titans Stock Screen
O'Shaugnessy's Tiny Titans Screen follows a fairly simple set of criteria. First, look at companies with between $25 million and $250 million in market capitalization. Second, take those companies with a P/S (price to sales) ratio of one or lower. Then, reduce it again to only stocks with at least $500,000 worth of trading in its shares each day. Then, of the companies remaining, take the 25 with the best price performance over the last 12 months and invest equally in each.
The results of this screen, which is first described in O'Shaugnessy's 2006 book Predicting the Markets of Tomorrow, are firmly positive. From 1951 to 2004, the screen would have produced real returns averaging 19 percent a year, exceeding a small-cap index return of only 10.44 percent. That means one dollar invested in 1951 would be worth nearly $10,000 by 2004.
The screen also has one major downside (depending on your perspective): volatility. The results for the companies selected were anything but consistent. The standard deviation from an average return (24.6 percent without adjusting for inflation) was a whopping 39 percent, meaning that 95 percent of the returns ranged from a 53 percent loss to a 102 percent gain.
Big Risk, Big Reward
While it's clear that any company on the micro-cap market represents a real risk, O'Shaugnessy's Tiny Titans screen really demonstrates that the rewards can be equally as large. Should a steel-nerved investor be willing to roll with the punches and take heavy losses at times, it's possible that using the Tiny Titans Screen will pay off in the long run.
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