Small caps are overpriced after a huge run, but you shouldn't abandon them entirely. Perritt Emerging Opportunities is one of the best no-load funds that specializes in these stocks and is open to new investors. By Steven Goldberg, Contributing Columnist March 20, 2007 Stocks of smaller companies have gotten pricey since the small-cap boom began in 1999. The best place to find bargains today is in stocks of large companies, particularly fast-growing companies. The worst place to look is among small caps.So why bother with a small-cap fund? Because short-term market swings are unpredictable. I'm willing to wager that large-cap stocks will beat small-cap stocks handily over the next five years, but it makes no sense to put all your money into any one type of stock fund. I wouldn't invest 20% of my stock money in small-cap stock funds, as I did during the past five years. But I think it's prudent to keep about 10% in small-cap funds. In investing, it pays to be humble. In that spirit, Perritt Emerging Opportunities (symbol PREOX) is one of the best no-load small-cap funds that is still open to new investors. The fund returned 15% in 2005, its rookie year; 16% last year and has gained 6% this year through March 15. Advertisement Older brother Perritt Micro Cap Opportunities (PRCGX) has a sizzling record. Over the past five years, it has returned an annualized 18%. That puts it in the top 1% among all small-cap funds. Michael Corbett, 42, has been day-to-day manager of Micro Cap Opportunities since late 1999. Gerald Perritt, who ran Micro Cap from its inception in 1988, still helps set overall strategy for both funds. But Corbett says he and his three analysts "dig into companies and find appropriate investments." That's a good thing because Perritt, an affable and intelligent finance professor, had a rotten record running the fund. I think Emerging Opportunities is the better of the two funds. Micro Cap Opportunities has $475 million in assets -- a lot for a fund that specializes in stocks of tiny companies. Assets in Emerging Opportunities total just $88 million. One negative for Emerging Opportunities is its high expense ratio of 1.67% (Micro Cap charges 1.29% a year). Both funds invest in tiny stocks, but Emerging Opportunities specializes in the tiniest stocks -- the part of the market where it's easiest to find bargains. The average stock in Emerging Opportunities has a market value (share price times number of shares outstanding) of just $75 million. Micro Cap Opportunities' average stock has a market value of $222 million. Academic evidence suggests that the smallest of small-caps tend to beat mere small caps over the long term. There is overlap between the two funds. Roughly one quarter of Corbett's holdings are in both funds. Advertisement Corbett may not be a genius, but he's smart enough and he works hard. Finding good stocks among tiny companies, which often are not followed by Wall Street analysts, is much easier than finding great buys among large-cap stocks. Corbett devotes some effort to identifying trends, but "we spend 90% of our time looking at individual companies." He follows two basic strategies. First, he invests in stocks that are priced attractively compared with their growth rates. This "growth-at-a-reasonable-price" strategy is one of the oldest and soundest on Wall Street. He also looks for companies that may not necessarily pass his value tests but have "created a business that's really exciting." That's a much more speculative approach, but Corbett never makes big bets. Emerging Opportunities owns 146 stocks, and none represent as much as 2% of the fund's assets. He and his analysts don't spend a lot of time on company visits, which is too bad. But company officials do visit them in Chicago, and the analysts attend lots of industry conferences. "We dig deep enough to ask long-term questions," Corbett says. "We want to know what the company plans to do over the next two to five years. We're not short-term oriented. We don't even listen to every quarterly conference call." Indeed, most of his companies garner so little interest from investment professionals that they don't have quarterly conference calls. Less than half the stocks in Emerging Opportunities have even one analyst covering them. Turnover is low. He holds stocks three or four years, on average. He'll sell in Emerging Opportunities if a stock's market value reaches $1 billion through appreciation, if it's no longer a good value or if he decides he made a mistake. Advertisement One of his favorite stocks is ACR Group (BRR), which services heating and air conditioning for businesses, mainly in the South. The work could hardly be more prosaic, but ACR looks like a good value. Corbett expects the company to earn between 62 cents and 65 cents per share this year, giving it a price-earnings ratio of just seven. MFRI Inc. (MFRI) also looks like a good buy based on Corbett's earnings expectations. The firm makes filters and pipes that help drillers get oil and gas out of the ground. Corbett estimates that it will earn $1.25 a share this year, giving it a P/E of 14. At the same time he expects double-digit annual earnings growth for the next several years. American Technology (ATCO) is a new business. It has no earnings or cash flow, but has a potentially terrific invention -- a way to project sound the way light is already projected. It can direct sound so that, for instance, four people could sit in a car and each listen to different music without headphones. It's a dicey play, but only a small part of this well-run fund. Steven T. Goldberg is an investment adviser and freelance writer.