Your Core Portfolio: Small-Cap Growth Stocks

by Lawrence Meyers | August 7, 2013 10:50 am

Today’s article assembles further specifics towards creating your “core portfolio,” which is intended as a diversified set of stocks to be held for the long-term, although a portion of it will be devoted to swing trades, options and speculative plays.

As an old math teacher once told me[1], it’s not a good idea to put all your eggs in one basket, unless you are absolutely certain that the path you’ve chosen is the best one for you.

Today, I’ll stuff the portfolio with small-cap growth stocks, but before I get to the picks, I want to lay out the asset allocation percentages that your core portfolio will contain (hyperlinks lead to the parts of the core portfolio I’ve already covered):

Asset Allocation Asset Allocation
Large-Cap Growth[2] 15% Options 5%
Large-Cap Value[3] 15% Midcap Growth[4] 4%
International/Emerging Market 15% Midcap Value[5] 4%
Income-Driven 14% Small-Cap Growth 4%
Special Situations 10% Small-Cap Value 4%
Swing Trades 10%

I’ll discuss the remaining categories over the next few weeks.

For now, with small-cap growth stocks, I want to anchor the asset class with at least one ETF or mutual fund, then turbocharge the rest of the class with stocks I want to own until their growth rate drops below 12% or so.

I’m grounding this asset class with a core position in the iShares Russell 2000 Growth Index (IWO[6]), a broadly diversified index whose top 10 holdings only account for about 6% of total assets. Small-cap growth companies tend to be heavy tech or biotech companies, and I generally don’t understand these entities well enough to evaluate them, so I find it best to use an ETF.

On the other side of things, there are a few stocks I do know very well in the sector that I will add.

I’ve written a lot[7] about Portfolio Recovery Associates (PRAA[8]) and Encore Capital Group (ECPG[9]) lately. Both companies buy charged-off debts[10] from the major credit card companies and other creditors, then attempt to collect on them. They pay as little as they can and collect as much as they can. The result is 16% projected annualized earnings growth. I am long both stocks. I think these cash flow generators are outstanding businesses.

SEI Investments Co. (SEIC[11]) provides investment and fund advisory services for institutions, advisors and rich people. Long-term growth is pegged at 15%, and it’s a free cash flow machine, generating more than $200 million-plus of it most years.

United Rentals (URI[12]) rents 3,300 classes of equipment to customers comprising construction and industrial companies, manufacturers, utilities, municipalities, homeowners and government entities. It’s also both a growth and value play, as it trades at only 10 times next year’s earnings but is growing at 20%.

The only reason I can even add this one tech play — FEI Company (FEIC[13]) — is because a friend of mine is in the same field and has explained the company and its products at length. FEI supplies scientific instruments such as transmission electron microscopes and scanning electron microscopes, which are used for research purposes in a host of fields, from cancer to semiconductors. FEIC is expected to grow at 17% annually, plus it has $315 million in cash, no debt, and generates a nice mid-eight-figure sum in free cash flow annually.

As of this writing, Lawrence Meyers[14] was long PRAA and ECPG. He is president of PDL Broker, Inc.[15], which brokers financing, strategic investments and distressed asset purchases between private equity firms and businesses. He also has written two books[16] and blogs about public policy, journalistic integrity, popular culture, and world affairs[17]. Contact him at[18] and follow his tweets @ichabodscranium.

  1. As an old math teacher once told me:
  2. Large-Cap Growth:
  3. Large-Cap Value:
  4. Midcap Growth:
  5. Midcap Value:
  6. IWO:
  7. I’ve written a lot:
  8. PRAA:
  9. ECPG:
  10. Both companies buy charged-off debts:
  11. SEIC:
  12. URI:
  13. FEIC:
  14. Lawrence Meyers:
  15. PDL Broker, Inc.:
  16. written two books:
  17. blogs about public policy, journalistic integrity, popular culture, and world affairs:

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