Meet the Perfect Stock

In 1998, Fool co-founder Tom Gardner selected the strongest company in America. And he didn't make this decision lightly. In fact, he evaluated dozens of criteria, and this company scored perfect in nearly every category.

Here's what he found:

  1. Extremely high profit margins.
  2. Superb working capital management.
  3. A world-class brand.
  4. Zero debt and a ton of cash.

Sounds like the perfect stock, right? It gets better: This company was smack-dab in the middle of a burgeoning industry.

What is it, already?
If you haven't guessed, it was Microsoft (Nasdaq: MSFT  ) , and Tom selected it over tech giants Intel (Nasdaq: INTC  ) and Cisco (Nasdaq: CSCO  ) as the world's premier "Rule Maker." If you're new to the game, a Rule Maker is a company with a dominant position in its industry and powerful competitive advantages. With the strongest entrenched network of any software provider in the world, Microsoft is a classic Rule Maker.

Nevertheless, Microsoft did carry risks. The Department of Justice was threatening to break it up. It also had a lofty valuation. Tom understood that Microsoft "might fall 50% at any given time," but he was confident that it would beat the market over many years. That long-term mindset is a critical aspect of Rule Maker investing.

We'll see if Tom was right about Microsoft in a moment, but first:

Just what makes a Rule Maker?
Individual investors should have at least a portion of their portfolio dedicated to Rule Makers -- rock-solid companies that investors can comfortably hold for 10 years, 20 years, or even longer. Rule Makers are leaders in their industry and have "moats" around their business that ensure they will continue to lead. The moat could be an entrenched network like Microsoft's, a recognized brand name, or a deep-seated corporate culture. In addition, Rule Makers have strong balance sheets, growing sales, substantial cash flow, capable management, and a reasonable stock price. These are the characteristics you'd do well to search for in a long-term investment.

If you think that's a tall order, you're correct. Rule Makers aren't easy to find. And the fact that we want to hold them for many years means we must be selective. When we identify that perfect Rule Maker, however, the rewards can be substantial -- think years and years of market outperformance.

This buy-and-hold strategy is quintessential Foolish investing, and it limits the commission-, tax-, and opportunity-costs of investing.

What are the new Rule Makers?
Some Rule Makers are not as obvious as Microsoft, so I recently asked our top analysts to pick their best "undiscovered" Rule Maker. I also added one important caveat: They could not choose a recommended company from our investment newsletter services, ruling out big hitters like Starbucks (Nasdaq: SBUX  ) , Disney (NYSE: DIS  ) , and eBay (Nasdaq: EBAY  ) , all of which are the premier names in their industries. I wanted new investing ideas.

Weeks of research and analysis gave rise to our new premium report, The New Rule Makers: 5 Power Stocks You'll Never Want to Sell. Some of these stocks are household names, but you may not realize the extent to which they are kings of their respective industries.

These titans make the rules that others must follow and present an opportunity to profit from the world's best businesses -- without taking on much risk. Like Microsoft in 1998, these companies have:

  1. Great brands.
  2. Protected moats around their businesses.
  3. Strong balance sheets.
  4. Reasonable valuations.

The cards are on the table
So, back to our question, how has Microsoft done since Tom fell in love with it in 1998?

We all know the story by now. Microsoft would spike to almost $60 at the peak of the tech bubble and then lose more than half its value in 2000. Over nine years, though (remember, long-term investing!), the stock is up about 88% since January 1998, compared to 60% for the S&P 500. Cisco, Tom's second-place Rule Maker, also beat the market with a 200% return.

That's the power of Rule Maker investing. Sure, Microsoft and Cisco were "obvious" choices, and we might have done better with some speculative small-cap growth stocks, but -- if you're like me -- you want to beat the market without placing long-shot bets.

While Microsoft has come under increasing pressure from Google and even longtime rival Apple, it is still arguably the premier name in software. Whether Microsoft is still the perfect stock today is a matter of debate.

Of course, if you're looking for new stock ideas and want to find out the world's leading Rule Makers of today, be sure to check out our premium report.

To learn more about The Motley Fool's just-published report, The New Rule Makers: 5 Power Stocks You'll Never Want to Sell, click here.

Joey Khattab does not own shares of any company mentioned. Microsoft and Intel are Inside Value recommendations. Disney, eBay, and Starbucks are Stock Advisor recommendations. The Fool has a disclosure policy.


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