Do This for Higher Short-Term Returns

Alexander Green|August 20, 2024

Editor’s Note: Today we’re handing the pen over to our good friend – and esteemed colleague – Alexander Green. If you don’t know Alex… you should. He’s the bestselling author of The Gone Fishin’ Portfolio, which has been helping ordinary folks live rich in retirement for more than 15 years. He’s also the Chief Investment Strategist of The Oxford Club.

In the essay below, Alex shares why he believes conditions are perfect right now for small cap stocks.

Now on to Alex’s essay…

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If you’re a trader who’d like to earn higher short-term returns, here’s a tip…

Don’t look for bargains in the stocks making new lows. Look instead for opportunities in the stocks making new highs.

It seems counterintuitive to many, but decades of research have shown that the stocks that reward investors with the biggest short-term returns are the ones that are already the strongest price performers.

Nvidia (NVDA) is a fine example.

As Isaac Newton said (in a very different context), “an object in motion tends to remain in motion.”

Market outperformers are generally companies that have outstanding sales and earnings growth, a durable competitive advantage, and increasing ownership by mutual funds, hedge funds and other institutional investors.

By contrast, stocks making new lows have often disappointed investors with subpar sales and earnings growth and margin contraction. The big financial institutions are bailing out.

In short, a long-term investor wants to buy low and sell high. But a short-term trader should look to buy high and sell higher.

(Of course, when you sell high, your entry price always looks low.)

However, there’s a way for traders to tweak their investment strategy to increase their short-term returns.

Yet it requires them to take a page from the long-term investor’s playbook.

Let me explain…

Sophisticated investors know that their asset allocation – how they divide their portfolio up among different types of stocks and bonds – is responsible for 90% of their long-term return.

Since their goal is to buy low, they generally invest in the asset classes that are laggards.

Why? Because they want to be holding that asset class when it returns to being a leader again.

Take small cap stocks, for example.

Companies with a market capitalization of $3 billion or less have averaged about 12% a year over the past century.

(Market cap is determined by multiplying the price per share times the number of shares outstanding.)

That is considerably better – 20% a year better – than the roughly 10% average annual return of large cap stocks.

Right now, however, small cap stocks are inexpensive based on price-to-earnings, price-to-sales, book value and dividend yield.

(That’s what makes them so attractive to asset allocators.)

Over the past decade, U.S. large cap stocks have returned 12.6% annually vs just 7% for small caps.

Yep. Small caps have been big laggards.

But when the cycle turns – as it always does eventually – small companies will once again outperform big ones.

That’s why contrarian asset allocators are now piling into the Russell 2000 index, the most prominent small cap benchmark.

However, if you blend these two approaches – buying market leaders but in an unappreciated asset class (the small cap sector) – you can seriously goose your returns.

Let me give you an example…

Last October, I recommended Blue Bird Corp. (BLBD) in my small cap trading service, Oxford Microcap Trader.

The company makes and sells school buses. (Try to contain your excitement.)

Yet here’s something most investors don’t know: school buses are America’s largest mass transit system.

And the market is highly regulated. Schools want buses that are low-emission, durable, serviceable and, above all, safe.

I noted to readers that the nation has an aging school bus fleet, and that Blue Bird is the market leader.

Over 180,000 of its buses are in operation today – and sales were growing at a 43% rate.

The market soon saw what we did – and within a few months we stopped out with a 56% gain.

Here’s another example. On December 19, I recommended that subscribers purchase Sweetgreen (SG).

I told them that the company was revolutionizing the fast-food industry with delicious, seasonal meals made with fresh, locally sourced ingredients.

The company was opening new stores at a torrid pace, using proprietary robots to assemble meals and cut costs. Revenue was growing at a 24% annual pace.

I told readers that, “rising sales, additional stores and the new efficiencies created by automation should drive earnings per share substantially higher in the months ahead.”

That’s exactly what happened. Sweetgreen smashed estimates.

We locked in a 109% gain less than five months later. And earned an 892% return on a related call option.

What do these two trades have in common? AI? Semiconductors? Software-as-a-Service?

Absolutely not. The two companies are not tech-related at all.

But they were rapidly growing companies in an underperforming sector: small caps.

And the asset class remains inexpensive today. The Russell 2000 barely eked out a positive return in the first half.

Yet if you look for rapidly growing companies in this asset class, you’ll be surprised by the short-term gains they can deliver.

As the old Alka-Seltzer ad promised: “Try it. You’ll like it.”