A New Tool to Beat the Market

Beating the market sounds easy, but it's tough to do.

Stocks that outperform the benchmark S&P 500 jump into the headlines every day. Hansen Natural returned more than 25,000% over the past decade. Chico's (NYSE: CHS) returned more than 8,700% over that same time frame. In fact, the 10 best stocks of the past decade all trounced the market's 106% total return.

So why do some three-quarters of all mutual funds still lose to the market?

Well, they're big. They can't invest in really tiny companies. Because of their size, regulations probably would have prohibited them from investing in Hansen's 10 years ago. A meaningful position, anyway, would almost certainly have run afoul of the law.

If you can't beat 'em, beta 'em
That's why The Motley Fool has often said, "If you can't beat 'em, join 'em." Index investing -- buying a broad-market index fund and going no further -- is a fine choice for many investors. In fact, even if you do invest in stocks, having an index fund as an anchor to your portfolio is a smart move, too.

You're probably familiar with the term "beta" as it relates to a stock's sensitivity to changes in the market. If a stock rises faster or falls further than the market does, it has a beta higher than 1, which usually means a stock that moves in tandem with a market. A beta lower than 1 means a stock is less sensitive to movements in the market. Yet beta is also a proxy for index investing. Matching the market is beta investing.

The alpha dogs
But we're stock pickers here. We're hunting for "alpha." We look for returns that go beyond just matching the market. "Alpha investing" is investing that looks for the excess returns beyond those achieved by simply indexing.

We've actually written about it before, though perhaps not in those terms. Called "Indexing Plus a Few," or IPF, it sought to juice the returns an investor could receive by adding a few stocks to her portfolio.

The IPF strategy was alpha and beta investing combined, but it was a little iffy. There was no assurance that your stock selection was going to make it to the "Year's 10 Best Stocks" list.

Putting on the CAPS
Now, The Motley Fool has added a way to boost your chances of finding the alpha dogs that will take your portfolio beyond average beta. Welcome to Motley Fool CAPS, the investor intelligence community where more than 22,000 professional and novice investors alike have rated thousands of stocks on their potential. The most successful investors are overweighted, and a stock's rating is born.

By harnessing the collective knowledge of tens of thousands of individual investors, CAPS immediately brings to bear a power to sort through the vast universe of stocks. You can focus in on those deemed to be the best of the best.

Here's a list of five top-rated stocks on CAPS today that have had tremendous returns this year.

Most people have probably never even heard of these companies. But 10 years ago, Chico's, 4 Kids Entertainment, and Frontier Oil probably weren't on most people's radar screens, either. Certainly, this is not a list of stocks to go out and buy, but rather a starting point for more research. No one should blindly buy a stock that appears on any list.

Foolish bottom line
Every stock investor ought to have ballast in their portfolio, and index investing provides that stability. Yet there are tremendous opportunities to beat the market with individual stocks, too. Alpha and beta, and now CAPS, make it as easy as A-B-C.

Make your voice heard on Motley Fool CAPS today. Follow this link for more information. CAPS is 100% free.

Fool contributor Rich Duprey unfortunately does not own any of the stocks mentioned in this article. You can see his holdings here. GigaMedia is a Motley Fool Global Gains pick. The Motley Fool's disclosure policy says: A-B-C! It's easy as 1-2-3!