Small-stock expert's top picks under $10

Investment newsletter editor Hilary Kramer sees opportunities in 'fallen angels.' She names these low-priced favorites and a few larger stocks worth a look.

By MSN Money Partner Sep 14, 2011 11:29AM

By Johanna Bennett for Barron’s

 

Former Wall Street pro Hilary Kramer has written the book on investing in small, low-priced stocks.

 

This summer's stock market sell-off hit small-cap stocks hard. But the 47-year-old newsletter editor for publications such as GameChanger Stocks and High Octane Stocks and the author of "The Little Book of Big Profits from Small Stocks" (available in stores next month), still sees plenty of investment opportunities in stocks that trade under the $10 mark.

 

Barron'sIt's an often ignored sector of the market, viewed as a dumping ground for broken companies. But Kramer, who spent years as an analyst at Morgan Stanley and Lehman Bros., argues that smart investors willing to roll up their sleeves and sift through the debris can find undiscovered gems, babies that got thrown out with the bath water and fallen angels about to make a comeback.

 

That's not to say she ignores bigger names at bigger share prices. Financial junkies who have read her newsletter articles or watched her frequent appearances on PBS' "The Nightly Business Report" have heard Kramer weigh in on a variety of names, including 3M (MMM), Pfizer (PFE) and United Technologies (UTX).

 

Barrons.com recently caught up with Kramer to discuss her picks and pans. Below are excerpts from our recent conversation.

 

Barrons: What's the attraction of stocks that trade for no more than $10?

 

Kramer: The book mentions several types of companies. I tend to gravitate towards "fallen angels" -- once high-flying stocks that suffered a big decline but are still able to overcome their troubles. Often, stocks are discarded for good reason. But you can also find some gems and for those investors looking for home runs, they can be very exciting.

 

Q: In reality, what portion of a portfolio should investors commit to small, low-priced stocks?

 

A: Small stocks should not total more than 25% of the equity side of your portfolio, because they can be so risky. The stock market's sell-off hit small-caps hard. While one stock might double or triple in value, four others might languish. Also, small companies often don't pay dividends - an important source of returns in today's current market environment. Some, however, do. At more than $7 a share, the television broadcaster Sinclair Broadcast Group (SBGI) pays a better than 6.4% dividend yield. It carries a lot of debt, but should generate strong revenue growth during the coming presidential election campaign.

 

Q: What should investors look for when gauging these stocks?

 

A: I look for growth and expanding margins. The company also needs pricing power to maintain sales in challenging times.

 

Q: What names offer promising returns right now?

 

A: Right now, I am seeing promise in small biotech names that are on the verge of rolling out next-generation, breakthrough targeted therapies. These include the cancer drug makers Ariad Pharmaceuticals (ARIA) and YM BioSciences (YMI). Optimer Pharmaceuticals (OPTR) has a drug that fights a deadly hospital-acquired infection. And lastly, there is Chinese biotech 3SBio (SSRX) specializing in anemia drugs. We've also been paying close attention to the small regional banks, such as Popular ( BPOP), Citizen Republic Bancorp (CRBC) and MPG Office Trust (MPG). Another name is Cowen Group (COWN), which was formed in 2009 when asset manager Ramius merged with the investment bank Cowen & Co. It has strong management and I love the business model. The shipping logistics company XPO Logistics (XPO) is a great example of a small company with the potential to grow into a much bigger name. With new management coming in it has the potential to do very well. We also like Ruth's Hospitality Group (RUTH), which runs the Ruth's Chris Steak House chain. During the market selloff, the stock fell from $7 to $4 a share. But it's currently trading at a very fair valuation, especially when you consider the price at which California Pizza Kitchen got acquired. (Editor’s note: Golden Gate Capital bought the restaurant chain in July for $470 million).

 

Q: What's your top pick among big-cap stocks?

 

A: It depends what investors want from a stock. Cummins (CMI) offers a real opportunity at $85 a share, down from its record high of $121 a share in May. The company makes engines for mid- and large-sized trucks and has been deemed a play on growth in the global-vehicle industry. But Cummins is really a play on clean technology and the push to reduce emissions thanks to its investment in natural-gas-burning engines.

 

Q: Name your favorite dividend pick.

 

A: Spanish telecommunications giant Telefonica (TEF) has an 8.3% dividend yield, and it's a great way to play Latin America. It's a huge company, though many people don't realize that it has a nearly $90 billion market cap. The stock price now sits below $20 a share, down from a high of $27.61.

 

Q: Let's talk about health care. Your book devotes an entire chapter to health-care companies. Also, a number of bigger names have been recommended on your newsletters, including Teva Pharmaceutical Industries (TEVA) and Gilead Sciences (GILD).

 

A: I am very particular about health-care stocks. I have to believe a company is in such a high-growth area that it can overcome the impact on its margins from Medicare and Medicaid reimbursement cuts and efforts by private insurers to cut medical costs. I love the Danish drug maker Novo Nordisk (NVO), which has fallen in price to $101 from $132 earlier this year. The company supplies insulin around the world and will profit from the growing global diabetes epidemic.

 

Q: What about other asset classes? What portion of an investment portfolio should be invested in equities right now?

 

A: It's important for portfolios to have equity, fixed-income and cash components. With equities, I tend to be an accordion, ranging from 20% to 40%. Many investors suffer sleepless nights during a market sell off. I see it as an opportunity to pick up bargains. When the market is frothy and overvalued, I sell off positions.

 

Q: What are your Sell recommendations? A recent newsletter mentioned Motorola Mobility (MMI).

 

A: We recommended buying Motorola Mobility in March and it climbed 43% before we put it on our Sell list last month following news of the pending acquisition by Google (GOOG) for $40 a share. The stock now trades at just below $38 a share. The arbitragers are probably having a field day, but for us, a 43% return is just fine. We've also recommended selling quite a few health-care names, including Brookdale Senior Living (BKD). The winds of change are coming quickly with the assisted living industry facing reimbursement issues.

 

Q: Drug -maker Dendreon (DNDN) was highlighted in your book as an example of a breakout stock. The shares skyrocketed amid high hopes for its groundbreaking prostate cancer vaccine Provenge, climbing above $55 a share last year. Last month, it was decimated because of disappointing sales. Will the stock recover?

 

A: I think eventually Dendreon will be acquired. In fact, some very smart investors I know are playing call options, believing it's only a matter of time. My research has uncovered new drugs being developed by other companies, including Johnson & Johnson (JNJ) and Bristol-Myers Squib (BMY), that might be more advanced and more effective than Provenge. That doesn't mean that Provenge isn't valuable. All that said, Dendreon is now at roughly $11 a share, and could get acquired for $17 to $25 a share. So there is money to be made here, no question about it.