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Online Extra: Big Fish, Small Fry, Tidy Gains

"Buy what you know" is supposed to be good advice for investors. But it can be disastrous for entrepreneurs because investing in small businesses like their own will leave them dangerously overconcentrated in risky, illiquid companies.

Can you have it both ways? Yes -- by investing in big public companies that cater to small ones. That's the tactic we suggested back in November, 1999, when we screened for companies that specifically target small business. We limited the search to those with more than $500 million in market capitalization, long records of success, strong earnings, and growth prospects. Our picks: Allied Capital, Paychex, and Staples.

So how did we do? Not too badly. From Nov. 1, 1999 thru July 20, 2001, the Standard & Poor's 500 index fell 12%, according to data from Multex. If you'd bought our whole portfolio, you'd have gained an average of 22%, adjusted for splits and dividends.

AND THE WINNER IS... Of the three, Paychex (PAYX) did best, up 49%. The payroll processor specializes in the thankless drudge work of issuing checks and keeping the IRS off an owner's back by tracking taxes, a job that an increasing number of businesses prefer to outsource. If you want diversity, Paychex has it: More than 350,000 small and medium-sized companies are customers, and revenues have been climbing despite the economic downturn.

Allied Capital (ALD), up 35%, uses a grueling due-diligence process to pick small and decidedly conventional companies to finance, often getting an equity stake. Its portfolio of more than 120 companies, diversified by geography and industry, has included a maker of igloo-shaped dog houses and another that makes cake decorating products. Insiders have been buying heavily, and with a recent dividend hike, the stock offers a generous 8.5% yield.

The one loser is Staples (SPLS), the office superstore chain, which is locked in a furious battle for market share with Office Depot and OfficeMax. Its stock fell 17% as sales softened throughout the small-biz retail sector. Unlike its rivals, however, which are pulling out of entire regions, Staples is still expanding: 95 new stores are set to debut in the next year -- on top of the 1,189 already open nationwide. It's also pouring enormous resources into its online effort,, where sales in the most recent quarter topped $212 million. Sounds like Staples still has big plans for small-biz. By Rick Green in New York

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