Morningstar Advisor - February/March 2011 - (Page 66)

Screens Big Opportunities in Small-Cap Stocks By David Krempa This screen looks for good buys in a hot part of the market. In 2010, the Morningstar Small Cap Index outperformed the Morningstar Large Cap Index by more than 10%. This added to an already long streak of outperformance by small-cap stocks. Small caps have outperformed over the past one-, three-, five-, and 10-year periods. During the past 10 years, small caps have crushed large caps by more than 7% per year on an annualized basis. With no signs that this trend is going to reverse in the near future, we thought it would be worthwhile to scan for some small-cap investments. at faster rates. It is a lot easier to increase revenue at high growth rates when a company is only doing $300 million in sales than when it is doing $30 billion. The smaller size of operations also allows small businesses to more quickly adapt and change strategies in response to a changing industry. With smaller stocks, firms also have the extra upside potential from the possibility of being acquired. Although we do not encourage blindly speculating on takeover candidates, if we find companies that we are happy to own as stand-alone businesses, the chance of a takeover is an added bonus. Of course, all of these benefits must be weighed against the negatives of small-cap stocks, such as fewer scale advantages, less-diversified business operations, and so on. And ( Moat Rating Or Moat Rating 5 Narrow 5 Wide ) When investing in small-cap stocks, it is important to find companies with moats. If a company does not have a competitive advantage, it will not be able to hold off larger competitors for very long. Bigger companies have greater scale and more resources, so they will likely be able to compete in the same market more profitably than a small company. The moat will help fight off competition from larger businesses. Moats are also important if you are looking for buyout candidates. Most companies would prefer to expand internally, rather than paying a premium to acquire a competitor in order to enter a market. If a small-cap company has an Size 5 Small Cap First, we searched for stocks that fall into the small-cap bucket. Small-cap stocks have a number of advantages over larger stocks. One of the benefits is the ability to grow sales 66 Morningstar Advisor December/January 2011

Table of Contents for the Digital Edition of Morningstar Advisor - February/March 2011

Morningstar Advisor - February/March 2011
Letter From the Editor
First, Do No Harm
Do You Use Active or Passive Investment Strategies?
Best of Both Worlds
How to Build an Index
Accountable Investor
Nice Guys Finish First
Four Picks for the Present
Investment Briefs
A New Guardrail Against Risk
Tech Loosens the Purse Strings (a Bit)
It’s More About Costs Than Active or Passive
Play Your Stars
In Between Active and Passive
Selling Beta as Alpha
The Weighting Game, and Other Puzzles of Indexing
Leaving the Nest
Redefining Credit Risk
Another Vote for Market-Based Credit-Risk Measures
Big Opportunities in Small-Cap Stocks
Benchmarks? What Benchmarks?
Mutual Fund Analyst Picks
50 Most Popular ETFs
Undervalued Stocks With Wide Moats
VA Sales Slide, but Assets on the Rise
Indexing’s Lunatic Fringe

Morningstar Advisor - February/March 2011