Radical Guide to Investing: Whatever Happened to Tech Uncovered?

In early 2003 (when I wrote the first version of this guide), five factors converged to offer the potential for significant appreciation in small cap tech and Internet stocks:

  1. Many small cap tech companies lacked Wall Street research coverage due to cuts in banks' research departments;
  2. Investors were avoiding these stocks due to fear of further losses;
  3. Many small cap tech companies had strong balance sheets, and therefore limited near term risk;
  4. Many small cap tech companies had become profitable or at least generated positive cash-flow;
  5. Yet in many cases the stocks traded below cash.

So I suggested that investors should consider focusing their stock picking on small and micro cap technology and Internet stocks. But I added the following caveat:

"As an investor, a key goal should be to diversify your portfolio and lower your risk. We’ve seen that you can successfully pick stocks if you (a) focus on the areas of maximum market inefficiency and (b) research a small enough number of stocks to give yourself an edge. But notice that then, by definition, you’ll end up with a highly concentrated portfolio of relatively illiquid and neglected securities. Not a good idea: too risky, and not suitable for the core of your portfolio. So you could invest in under-followed small cap and emerging market stocks to boost your returns and to complement your core portfolio, but certainly not to replace it."

What happened? In 2003, the Wilshire Micro-cap index rose by 92%. I planned to devote my time to picking neglected small and micro cap stocks, and then writing about them (with full disclosure of ownership) in my free newsletter. The name of the newsletter?  Tech Uncovered, suggesting the neglect of small cap tech stocks reflected by their lack of Wall Street coverage, and the act of uncovering their value by writing about them.

Well, half the plan worked out. Luckily, it was the more lucrative part. After intensive research (including meeting with managements and calling industry sources), I purchased relatively large positions for myself in Tripath Technology (TRPH) for $0.66 and Hollywood Media (HOLL) for $1.25. As of early 2004, I still own both stocks, though I've trimmed my positions; you can check the current prices for yourself. My portfolio was up 195% in 2003. Lucky, since I was no longer working as a research analyst for Morgan Stanley...

But the Tech Uncovered part didn't work out. A lawyer warned me that writing about illiquid micro cap stocks in a newsletter was potentially illegal, even with full disclosure of ownership. And because I'm thinking of launching a hedge fund that focuses on small and microcap stocks, writing about these stocks raises other legal issues. So the micro cap recommendations of Tech Uncovered never saw the light of day (or should I say of computer screens), and Tech Uncovered has been relatively dormant since.

With the dramatic rise in the indexes in 2003, small and micro cap stocks no longer seem like such a bargain. Moreover, numerous research boutiques have decided to focus on these stocks, so the information inefficiency that allows for alpha generation has likely subsided somewhat.

All this means that regular investors should be extra skeptical about the chances of success when picking individual stocks, even as a small adjunct to a core portfolio of index funds. Better just to stick with the ETFs (as I'll explain in later chapters of A Better Way To Invest). Meanwhile, Tech Uncovered will now focus on articles about investing and perhaps occasional analysis of broader technology trends.

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June 1, 2005 | Permalink


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