First Round! Small Caps and Soccer Teams Advance
Like many of you, I’ve spent time watching the World Cup soccer tournament this week. The event has spurred my interest in African stocks and ETFs - especially since the emerging economy shares some common characteristics with the small cap asset class. Most notably, the country is compelling for investors with a risk appetite, similar to the risk appetite of small cap investors. And like small cap investors, emerging market investors have their appetites rewarded by the potential for massive upside. So I'll discuss specific investment ideas that I come across as the tournament progresses.
I recently read that many employers are trying to figure out how to best maintain productivity levels as workers around the world flock to any medium possible to watch these world-class matches. Unfortunately, they haven’t found a cure yet.
In the spirit of this global tournament, I thought I’d update you on our little “competition” – the preliminary listings of the Russell Reconstitution. If you missed last week’s issue, you can visit our new website at www.smallcapinvestor.com to get caught up to speed! That's right, our new site is now up and running - take a tour and let me know what you think. You'll notice the daily blog hosts each issue of Small Cap Investor Daily, and in a few more weeks the content for Small Cap Investor PRO will be available to subscribers of that advisory service - all from one website.
***Last Friday after the market closed, the good people over at Russell published the preliminary list of additions and deletions to their new indexes. Click here for a full list of the preliminary additions and deletions to the Russell 3000. A bit belatedly, (and before the Ivory Coast vs. Portugal match) I present the results of the four firms we’ve been following:
Golden Star Resources (AMEX: GSS)
The Colorado-based gold miner advances to the next round! Since I filled you in on the company last Wednesday, the stock price has gone up about 3%. With gold prices so high and widely discussed, this firm might be trading more on commodity news rather than just the Russell update - but I'm glad to see the company made the cut regardless.
Targacept (NASDAQ: TRGT)
This biopharmaceutical company also advanced. The firm’s share price has gone up a respectable 5% since last Wednesday.
ArthroCare Corporation (NASDAQ: ARTC)
The medical device maker also made it out of 'group play' as a preliminary addition to the new Russell 2000. The stock price for the company has edged up slightly, but is essentially flat since I brought it to you attention last Wednesday. The firm's inclusion is a positive sign that the company is moving past the accounting problems of prior management.
LTX-Credence Corporation (NASDAQ: LTXC)
Rounding out the group, LTX-Credence, the semiconductor testing firm made the listing. I spent a little extra time researching LTX-Credence in last Thursday's letter, and I’m glad that I did. Since I initially recommended it, the share price has shot up about 7%. Hopefully you were able to use my research to help make a profitable investment.
***I’m not going to spend too much time patting myself on the back just because I went four for four with these small cap stocks - but I'm happy that they all made the cut. And I hope you had a chance to check them out and decide for yourself if they are worth taking a position in.
If you took equal, small positions in all four of these stocks when I pitched them last Wednesday, you would now be sitting on a gain of 2.5%.
***Keep in mind that last year, additions saw an 8% bump on the day that changes to the Russell were finalized. This year, that day is June 25. The theory is that large funds buying and selling stocks to correctly mirror the new Russell cause a short-term bump in share price for new additions.
My latest pick for the Small Cap Investor PRO portfolio was also added to the Russell. It’s an energy firm with strong fundamentals that has recently been active in the mergers and acquisitions space. For more information about this great company, click here.
A few days ago I received an email from a reader discussing a Russell research paper, “Price Pressure at Russell Index Reconstitution,” on the reconstitution effect. The paper argues that the reconstitution effect has diminished in recent years, most notably due to:
1. 1.)The decreased number of index changes in the recent relatively low-volatility years
2. 2.) Recent changes in the index methodology
3.) An incrase in short positions and active strategies in recent years.
Both Russell’s paper and the paper I cited in the earlier article, “The Russell Reconstitution Effect” suffer from small sample size. Another paper I found on the topic, “The Russell Reconstitution Effect Revisited,” uses the same data set as the Russell-published “Price Pressure” paper. Both papers find that the overall effect has diminished, though neither focuses on the Russell 2000. Further “The Russell Reconstitution Effect Revisited” paper reports a significant increase in share price of additions within the few days surrounding the Russell Indexes’ finalization.
The Russell Reconstitution effect is an interesting topic worthy of further research. It is debatable whether or not there are significant speculative gains to be made by investors in the run-up to the finalized listing. However, for stocks added, there certainly seem to be significant price increases in a tight band around the finalization date.
If the pattern were to hold up again this year, then the current run-up in stock prices is more or less a precursor to the main event - the final listing day.
***From a less speculative point of view, the long-term benefits of being listed on the Russell are pretty significant - most notably that small companies typically have little exposure to potential investors. But that changes when added to the Russell Indexes.
This benefit is referred to as the Index Membership Hypothesis. The hypothesis states that when a firm is listed to an index, it increases in intrinsic value. As I wrote last week, “...inclusion means analyst attention, a broader investor base, increased liquidity and greater exposure to institutional investors.”
This 'membership effect' means much less to companies that get listed on the Russell 1000 of large firms. But for small companies being listed on the Russell 2000 could ease the path to financial success.
I’ll keep an eye on the Russell Reconstitution throughout June. As investors we should always be on the lookout for good companies with strong fundamentals. The better we understand the reconstitution and the exposure that inclusion can give to tiny small cap stocks, the more upside we can gain from the annual rebalance.
Go Ivory Coast!
