Another Path to Profit: Riding Microsoft's Coattails

Investors always like a winning story. Impressive long-term returns from companies such as Hansen Natural and Wal-Mart captivate our attention and serve as a guide for finding the next great stock. Investors in software behemoth Microsoft (Nasdaq: MSFT) have taken part in a great story as well -- stock in Bill Gates' iconic company has risen more than 100-fold over the past 20 years.

But Microsoft has struggled to maintain historic growth rates recently, and the stock has only appreciated 30% over the last five years, underperforming the S&P by 34%. And while there's considerable debate today about whether the company will reverse the trend and beat the market going forward, there are many alternatives to profiting from a company that has already proven itself a winner. Riding the coattails of an industry-creating company can sometimes be even more profitable for investors. First, however, it helps to know where to look.

Finding the tail on this coat
There's no doubt that Microsoft completely revolutionized the world of personal computer software. But it's tough to move the needle on a $285 billion software company, even with hugely profitable sales of office productivity software. There may, however, be some compelling investment opportunities out there that share in Microsoft's success, but offer much better growth potential. If we can nail down some companies profiting from the burgeoning ecosystem Microsoft is driving, maybe we'll find a buried treasure worthy of investment.

I think conventional wisdom about coattail companies is sometimes too limited. Typically, investors think that coattail companies are simply direct suppliers or partners of a large, successful firm. But I think there may be even more opportunities hiding from investors, beyond direct connections with an industry leader like Microsoft.

In fact, some companies offering attractive products and services indirectly related to Microsoft's core markets end up being bought by the cash-rich giant. For instance, in the last several months, Microsoft has moved to acquire digital ad leader aQuantive (Nasdaq: AQNT) and voice-based search firm Tellme. It's part of Mr. Softy's response to competitive threats from the likes of Google (Nasdaq: GOOG) and Yahoo! (Nasdaq: YHOO).

For instance, a company can find great success by selling niche application software that Microsoft doesn't. Alternately, it can sell tools to manage tasks or problems that inevitably crop up in software -- disk inefficiency, spyware, and memory management, to name just a few. This is where Motley Fool CAPS can really help; the Fool's massive stock database has abundant tools for finding and researching stocks and stock pickers.

Tagging along with CAPS
With CAPS, investors can look through Microsoft's tag list for other companies sporting similar attributes. For instance, Microsoft has tags such as "Business Services," "Paid Search," and "Application Software." Additionally, links to Motley Fool analysis, news releases, and discussion boards are also at your fingertips.

CAPS also lets investors comment on the companies they rate. Their opinions often contain peer analysis and recommendations for other related companies. Sometimes, these resources turn up companies that have little or no direct connection to Microsoft, but contain similar qualities that could make them attractive investments.

Perusing the tags, comments, and blogs could lead an investor to interesting companies such as enterprise software firm American Software (Nasdaq: AMSWA). This profitable small cap has found a good niche among giants such as SAP (NYSE: SAP), providing tools and services to make supply chains and resource management more efficient. Another interesting prospect is leading online Korean e-tailer GMarket (Nasdaq: GMKT), which some investors refer to as the Korean version of eBay. GMarket's ability to scale its online platform to handle increasing numbers of buyers and sellers has many CAPS investors optimistic about its future.

Tail-wagging
Of course, plenty of coattail investments have proved to be shallow copycats that ultimately flopped for investors. For this reason, CAPS is best used as a research tool, rather than an automated investment-picker. Investors should always perform their own due diligence on companies, rather than taking a blanket recommendation. But for the price -- absolutely free -- you can't beat CAPS' information and resources. Give it a try today.

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Fool contributor Dave Mock has never worn a coat with tails; he prefers the waiter style. He owns no shares of companies mentioned here. Wal-Mart and Microsoft are Inside Value recommendations. Yahoo and eBay are Stock Advisor recommendations. aQuantive is a Rule Breakers pick. Dave is the author of The Qualcomm Equation. The Fool's disclosure policy is often imitated but never duplicated.