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- Alan Lavine and Gail Liberman

These days, the over-the-counter stock market is the only place to find rising stock prices. Many companies listed there are beaten-down small company stocks that have been ignored for years and are now making a comeback.

But small company stocks, which are thinly traded, are fraught with risk: Their prices are highly volatile; there is no guarantee that these young companies will mature into blue-chip stocks; and, there always is a danger that the business may fail.

Having said that, small stocks are one of the few areas showing positive returns this year and are outperforming mid-size and large company stocks. Undervalued small company stock funds were up 16 percent in 2001. By contrast, the S&P 500 index of large company stocks lost 11.8 percent.

The Century Small Cap Select Fund is having a particularly good year. The fund is up more than 12 percent over the past two years. It hasn't set the world on fire, but it is a relatively new fund offered by an investment company that has a knack for investing in undervalued stocks.

The fund invests its assets in insurance companies, insurance brokers, banks, healthcare, financial technology, business services and education services.

Especially interesting, says Lanny Thorndike, portfolio manager of the fund, are educational services stocks.

"The sector is almost as large as the technology sector but educational services companies are not tracked by legions of analysts," Thorndike says. "This means many of these companies can be purchased below their true value, providing opportunities for long-term growth."

Thorndike likes to invest in companies with proven management teams. The companies must have a growing market share. Earnings must grow in both good times and bad. The companies must be cash rich and have little debt. And, their stocks must be cheap compared with their peers.

Stocks he likes include:

  • Investors Financial Services Corp., a custody bank that provides mutual fund processing to the investment community. The company is growing twice as fast as its competitors. Earnings are expected to grow at 25 percent annually over the next five years.

  • American Capital Strategies, a financing company for small businesses. This company lends to small businesses that can't get financing from banks. Earnings are growing at 13 percent annually. The stock is cheap based on future earnings. Plus, the dividend yield is a whopping 8 percent.

  • HCC Insurance Holding. This is a specialty property and casualty insurer. It is benefiting from the rise in insurance premium rates. The company is expected to grow earnings 25 percent annually.


    Alan Lavine and Gail Liberman are husband and wife columnist and authors of The Complete Idiot's Guide To Making Money With Mutual Funds, (Alpha Books).

    To read more columns, please visit the column archive.

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