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Your Core Portfolio: Small-Cap Value Stocks

This asset class has the greatest return potential


Today, we continue to construct your “core portfolio.” As a reminder, the concept of the core portfolio is to create a diversified list of holdings that are designed to last for years.

Of course, you should still rebalance your portfolio — which you can see below, along with hyperlinks to the parts of the core portfolio I’ve already covered — every six months or so, particularly as stocks shift into a different asset class. One example: When a small-cap pick becomes a ten-bagger!

And that brings us to my favorite asset class: small-cap value stocks. These stocks should make up around 4% of your holdings.

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

I’m partial to small-cap value stocks because they tend to be in businesses that people don’t like or don’t understand, and they have the best chance of becoming multi-baggers.

Of course, there’s two sides to that coin. A common tale of woe for small-cap value stocks is selling too soon. The classic example is Jos. A Bank Clothiers (JOSB), which I discovered while walking in Manhattan one day in early 2001. I bought the stock at $5 and sold it at $8, thinking I was a genius. But when a story is good, it’s good. Had I held, I would have made far more.

Anyways, what’s past is past … and now it’s time to pick some new names. The two main things I like in small-cap value stocks are a market cap under $3 billion and a PEG Ratio under 1.

To start, I’m anchoring this asset class with an exchange-traded fund … as always. I like the iShares Russell 2000 Value Index (IWN). The top 10 holdings, which make up about 4% of the ETF, are mostly obscure names like the bank Firstmerit Corp. (FMER) and specialty chemical company Axaill Corp. (AXLL).

Next up, I always turbocharge each asset class with additional holdings. Anyone who follows my columns even relatively regularly already know my three favorite stocks at the moment are pawn-shop owner EZCorp (EZPW) and debt collection stocks Portfolio Recovery Associates  (PRAA) and Encore Capital Group (ECPG).

These are also my first picks for our small-cap value stocks. The former trades at roughly half its fair value, while the last two collect three to five times what they pay for bad debt.

Another good pick is the small-cap value space is actually in the hotel REIT sector. I’ve followed Ashford Hospitality Trust (AHT) since its 2003 IPO. Three things to like: Ashford dividend yields 4.1%, its CEO has 23 years experience in hotels and the company has always deployed its capital prudently and with solid returns.

Last but not least, I also like Dorman Products (DORM) — a nice, boring company that operates in the high-margin field of automotive replacement parts. It’s PEG ratio is a bit over 1, but I forgive it because it has solid cash flow and no debt.

That’s all for this week, folks … but stay tuned! Next week, I’ll get into income plays.

As of this writing, Lawrence Meyers owned shares of IWN, EZPW, PRAA, ECPG and AHT.

Article printed from InvestorPlace Media,

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