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The small-cap queen
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June 16, 1999: 11:31 p.m. ET
Irene Hoover shares her rules for investing in small companies
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NEW YORK (CNNfn) - When Irene Hoover goes shopping for bargains among retailers, she is looking not for deals on dishes or rugs or furniture. She is seeking cheap prices on stocks.
Hoover is a mutual fund manager who invests in small cap stocks, companies with a market value of less than $1 billion.
"It's a high risk, high reward area of the market," she said.
High risk because she invests in companies many of us have never heard of. Even so, from 1994 to 1997, Hoover's Forward Fund was the best performing mutual fund in the business. It averaged gains of almost 50 percent a year. How did she do it? We took a lesson from the small cap queen.
This is one of her recent picks; Cost Plus Inc. (CPWM), a California retailer that is expanding nationwide with its Cost Plus World Market stores. "You want to see if there are customers in the store, you want to see that there's good checkout," she explained. And if you doubt an investment specialist would go into the store to check things out, she replied, "You have to do that. Especially in retail. And you want to see if the goods are moving."
Small cap rule No. 1: Identify a trend before anyone else figures it out. For example, have you noticed how a lot of bridges and roads are crumbling in major cities? So did Hoover. So she latched on to a concrete company, expecting heavy demand in the future.
What grabbed her about Cost Plus is the fact that they mixed groceries, coffees and a large wine collection with things like furniture and dishes.
"These glass tables, I bought one for my daughter who is starting her apartment," she said, gesturing to the furniture. She really does base her investment decisions on things she knows. "I like to. It really works out better. You can keep tracks of it that way. You also know what you're investing in."
Hoover's small cap rule No. 2: Never invest in something you don't understand.
"You for instance would probably be able to find a broadcasting company and know about it better than I would right away. You would know the quality of people running it, you would know the quality of the programming," she said in an interview.
Hoover has another important rule: Check out the management, as we saw her do with the CEO and chief financial officer of Cost Plus, peppering them with questions: So you're below the price points of your competitors for the most part? How many stores can you eventually get to throughout the country? Have you had any trouble in Asia?
Getting the information
While you may not be able to grill the CEO of a company, you can find the answers to a lot questions on the Internet. It's easy to pull up financial data on a company, and Hoover recommends that you pay close attention to the earnings.
"See, if the earnings are growing 20 percent and the stock goes up 200 percent, then maybe the Street has gotten too enthusiastic about the stock," she observed.
But lately even a savvy shareholder like Hoover has had trouble making much money on small caps. The best known gauge of small cap stocks is the Russell 2000 index, but it's been lagging behind the market, gaining less than 15 percent a year. At the same time the Dow has almost tripled.
"Market watchers say that small caps, on a valuation basis are cheaper now then they have ever been in history," said Fortune magazine's Bethany McLean. But those cheap prices may not matter to a modern day Wall Street that's dominated by huge mutual funds.
"Small cap companies complain constantly that they are neglected. They have a very tough time getting Wall Street research analysts to follow them, to pay attention to them. There are small companies that will say that I have grown my earning at 20 percent over the last five years and no one will pay attention to me," McLean said.
That's because Wall Street is dominated by big mutual funds that have so much money small caps just aren't worth their time.
"There is an advantage to size," McLean said. "It gets you noticed."
But size may not be everything. Most of the biggest companies in the nation started out as small caps. Microsoft (MSFT), Intel (INTC), Wal-Mart (WMT) and Home Depot (HD) were all small caps in the mid 1980s. And Charles Schwab (SCH), today a company worth $43 billion, was a small cap just seven years ago. By the way, guess who discovered it.
"I think the one I'm proudest about is being the first to discover Schwab. The discount brokers were just beginning. You only had a few of them and Schwab was the leader of a niche," Hoover recalled.
We'd all like to be the one of to discover the next Schwab, but be advised that small caps stocks are riskier than most, she warned: "Because it is a volatile market place, companies change very rapidly. They don't have the great resources behind them."
With small caps you're taking a chance on the little guy, but if your hunch is right, the payoff can outweigh the risk.
And if this reminds you of gambling, Hoover said, "Maybe you're not sitting there doing all the hard work that we do trying to find out how these earnings are going to propel the stocks up."
Which brings us to what may be the most important small cap rule of all. If you don't know what you're doing hire someone who does. 
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