Understanding the Daruma Pompano Index (DPI)

One of my favorite books on investing is legendary money manager Marty Sosnoff's Humble on Wall Street, published in 1975. It's a hilarious romp through the late-60s gunslinger's market and the vicious 1974 bear market.

The war stories contained within remind me that precious little has changed when humans and markets collide. Among the many gems, the following unforgettable lesson is my favorite:

"In the late Sixties, a group of superspeculators met monthly over dinner. A dozen of us would sit around and tell our most promising stories. I heard thousands but the best we all agreed was the one about pompano. They were to be raised in a controlled environment - a super fish farm. There is never enough sweet pompano to go around and I think the price per pound was a dollar fifty or two bucks. The company was going to hatch the eggs, grow the fry in tanks and then raise them to a couple of pounds and ship out five to ten million pounds of fish a year and make $10 million from a standing start.

"We all tried to shoot this one down. What would happen to the price of pompano if 10 million incremental pounds came on the market? Could Ralston Purina ship enough feed to grow the fish? How would they taste? How proprietary was the process? All our questions were answered and some of us even went down to Florida to watch the eggs hatch and inspect the fry swimming around in the 2000-gallon tanks. It was all very exciting and we saw every fish house in the country featuring fresh pompano a la carte till the end of time. We couldn't wait for the next monthly meeting to find out how fast the fish were putting on weight. Then the news hit us - all the fish had sickened and died. Nobody at the company knew why. The fish had died and we all burst out laughing hysterically - laughing at ourselves for none of us had dreamed that the fish could die. This is bull market thinking - the fish never die."

Given that this grizzly of a bear market has flung a lot of dead fish around, I thought I would remix Sosnoff's story with an idea from Calculated Risk, our favorite credit market blog. Specifically, we've come up with our own list of vital signs for the small-cap market (and the fish that are still swimming).

We call it the Daruma Pompano Index (DPI). Here's how it works...

We ran an elementary screen on November 30th, deliberately casting our net wide: Stocks at or under $2 billion in market cap; listed on the NYSE, Nasdaq or the AMEX; with sales of some kind, even if only one dollar. 3,736 companies made the cut.

Each month, we review this list and note:

We’ll also share any new insights we fish out from the pond as we go.

So there you have it: the five vital signs of small-cap life worth watching. We'll update these monthly, and for now, let's hope that Purina can ship enough chow to keep these fish growing.

© 2008-2010 Daruma Asset Management, Inc.

Pompano Index

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