3 Hidden Gems the Big Boys Can't Touch

As an individual investor, you have one of the best advantages in the stock market.

Whenever I hear someone talk about how some big-shot investor has a leg up, I remind them that individual investors like you and me have the biggest advantage of all: We're small.

But wait -- why is that an advantage?

Because the best stocks out there -- the ones with the highest potential for gain -- are the ones that only individual investors can buy in quantity.

Below I give you three great small caps to turn into major profit -- stocks that are much too small for the big boys to touch. I'll also give you a chance to download a free special report with the names of two more "too small to fail" stocks.

The disadvantages of size
Size is a massive disadvantage when it comes to investing.

Superinvestor Warren Buffett has complained about it for years. At a $168 billion market cap, his Berkshire Hathaway (NYSE: BRK-A  ) (NYSE: BRK-B  ) investment vehicle is just too large. With such a large company, only big acquisitions will meaningfully increase its value. And there are only so many good deals floating around in the large-cap world.

You can see Buffett's fate reflected in Berkshire's $48 billion cash hoard, which he has a hard time deploying into profitable investments. It's even more obvious in Berkshire's declining performance over the last few decades:

Period

Average Annual Increase in Book Value of Berkshire Hathaway

Increase in S&P With Dividends Included

Relative Performance

1965-1969 18.1% 6.4% 11.7%
1970s 23.3% 7.4% 15.9%
1980s 29.5% 18.1% 11.4%
1990s 25.3% 19.0% 6.3%
2000-2009 8.8% 1.2% 7.6%

Source: Berkshire Hathaway's 2008 annual letter.

That's a solid performance by any measure, no question about it. But even the Oracle of Omaha can't outperform forever. His relative performance over the last few decades has steadily declined, as you can see by the column on the far right. And Buffett has long said that he could generate 50% annual returns if he had less than a million dollars, meaning that he'd love to buy small caps.

But Berkshire's inability to buy small caps is all the better for us. They're the sector with the greatest potential for outsize returns. As I've noted before, "Finance gurus Eugene Fama and Kenneth French discovered that one in eight small-cap growth stocks becomes large each year. ... These soon-to-be large companies return up to 62% on average annually."

Three value-priced small caps
As I promised at the start of this article, I'm going to detail three small caps that are poised for great returns. They're cheap and underfollowed by Wall Street's big money.

Aeropostale (NYSE: ARO  )
This retailer of clothing to adolescents and pre-teens has suffered a beat-down lately, as cotton prices have played havoc with its margins. Commodities such as cotton are highly volatile but will ultimately return to more typical levels. Peer lululemon athletica (Nasdaq: LULU  ) has avoided that crunch by using synthetic fabrics, whose price has remained more stable. In the meantime, shares of Aeropostale are cheap at a market cap of just $825 million, the management team is proven, and the company still has room to grow (such as through its P.S. chain that caters to kids). Management has been aggressively buying stock -- $318 million over the last four quarters.

National Presto (NYSE: NPK  )
National Presto is the duck-billed platypus of the investment world: a maker of kitchenware, ammunition, and adult diapers. The company's customers are concentrated, but the stock trades for less than 9 times this year's earnings. And the stock has gotten hurt by its association with the defense industry, which is experiencing cutbacks, and pushing the P/Es of well-established players like Northrop Grumman (NYSE: NOC  ) into the single digits. But unlike Northrop, National Presto offers a hidden dividend, as my fellow Fool Anand Chokkavelu explains. While public sites report a yield of 1.1%, National Presto regularly pays a special dividend, which amounted to about 8% at current stock prices.

And now for the cheapest, best stock I see

SUPERVALU (NYSE: SVU  )
This grocery chain's name says it all: it's trading at just 5-6 times this year's earnings -- in other words, it's incredibly cheap. The company is in the middle of an operational turnaround and is working to pay down its heavy slug of debt, but that provides a great opportunity for nimble investors like us. The vast majority of its debt doesn't come due for years, and SUPERVALU's solid profitability allows the business to deleverage, rapidly increasing its book value to shareholders. The company also sees some solid growth opportunities in its Save-a-Lot discount chain, from which it collects high-margin revenue through franchising.

Foolish bottom line
Each of these three stocks is being followed by our Motley Fool Hidden Gems team, which identifies great small caps and then puts real money behind their picks. The Hidden Gems team has also identified two small caps that are too small to fail. If you'd like free access to these two small caps "the government won't let go broke," just click here.

Jim Royal, Ph.D., owns shares of SUPERVALU, Aeropostale, and Berkshire. The Motley Fool owns shares of Northrop, Lululemon, National Presto, Berkshire Hathaway, SUPERVALU, and Aeropostale. Motley Fool newsletter services have recommended buying shares of Berkshire and Lululemon, as well as buying calls in SUPERVALU. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.


Read/Post Comments (11) | Recommend This Article (80)

Comments from our Foolish Readers

Help us keep this a respectfully Foolish area! This is a place for our readers to discuss, debate, and learn more about the Foolish investing topic you read about above. Help us keep it clean and safe. If you believe a comment is abusive or otherwise violates our Fool's Rules, please report it via the Report this Comment Report this Comment icon found on every comment.

  • Report this Comment On September 12, 2011, at 6:02 PM, Pandorabelle wrote:

    There are certainly some *Big Boys* who can *touch* any of the three listed by manipulating it at will.

    The desirable volatility CREATED by Big Money to swing trade in the short term can frustrate and exhaust the small retail investor who is looking to invest based on supply, demand and value...since the market is more of a casino with an "anything goes" mentality these days.

    The market won't be regulated because the regulators don't want to lose their cut of the cash cow. It's a playground for Big Money bullies where you enter at your own risk.

  • Report this Comment On September 12, 2011, at 9:11 PM, PagoJeff wrote:

    I am VERY small investor... <100K, however, in the 5 years I've been a MF subscriber, with Hidden Gems and Special Ops as a couple of my subs; I'm up almost 20K. That's not too bad, so I'm not loosing sleep with the "Big Money bullies" out there.

  • Report this Comment On September 13, 2011, at 10:35 AM, CommanderFlipper wrote:

    In the discussion of SVU, it would have been most useful for the author to mention that SVU was #4 on the list of those S&P 500 stocks that are most shorted. Do the shorters know something we don't?

  • Report this Comment On September 13, 2011, at 11:06 AM, dlomax77 wrote:

    The shorts don't need to know anything we don't. Losing more than $7 per share ttm and holding almost $7B in debt are reason enough to short SVU. If you like the reorganization, be a contrarian. If not, stay far, far away.

  • Report this Comment On September 16, 2011, at 11:50 AM, chitownjester wrote:

    @Sundolly, You will not be a successful investor as your priorities (as you state: "supply, demand and value") are fatally flawed. Investors never invest based on supply or demand- this is the provenance of speculators and manipulators. Investors always invest based on identification of securities trading below intrinsic value.

    As Warren Buffett has put it- "invest as if the market will be closed for 10 years". Meaning invest ignoring the incessant to-the-millisecond supply/demand data streaming from the ticker- and focus solely only the bottom up analysis of intrinsic value, and whether that value is (substantially) more than the price you can pay"

  • Report this Comment On September 16, 2011, at 11:54 AM, chitownjester wrote:

    @Sundolly, Further, the manipulations of the market, the distortions and emotions, are actually your friend. Because they are the forces providing you and I the ability to buy a company for less than intrinsic value. They are the reason the Efficient Market Hypothesis, as incorrectly interpreted by some to narrowly mean that all securities are always priced according to their worth, is bunk.

  • Report this Comment On September 16, 2011, at 1:06 PM, jrj90620 wrote:

    I don't know about performance of SuperValue's stores in the rest of the country,but I can tell you that SuperValue(Albertsons),Safeway(Vons) and Kroger(Ralphs) are all getting killed,here in the center of So California.So much competition from non union Hispanic,Asian and Middle East markets combined with more food at Walmart,Target plus Costco,CVS,Walgreens,Whole Foods,etc.I think this country is overstored and a lot of these retailers will be closing locations.Avoiding this sector.

  • Report this Comment On September 16, 2011, at 8:03 PM, peters46 wrote:

    I view BRK's performance in a much better manner, practically making its performance glow. From 65 to 70's you rate it in the teens, I rate is at over 300%. With a huge slowdown in the 80's and 90's to less than 200%, but coming to the fabulous 0's, over 700%. I am quite happy with its performance in the last ten years. Unfortunately, when I decided to buy, a little over ten years ago, I could afford only what gave me 50 B shares today.

    john p

  • Report this Comment On September 16, 2011, at 8:11 PM, kcajc1 wrote:

    Who is controlling the Market, the big boys or the little boys. Might take a long while.

    Jack

  • Report this Comment On September 18, 2011, at 11:54 AM, LSLOANPDX wrote:

    I am both a paying premium member and also subscribe to your income/dividend letter.

    You should always include the ticker with every company. (You are doing better) but:

    Please start showing yields with every sticker even if is 0. Forcing us to do that kind of research after we have paid for a service is WRONG.

  • Report this Comment On September 22, 2011, at 3:45 PM, speremmu wrote:

    I believe it was warren Buffet himself who said that companies should retain earnings only if they can get a better return than what an individual investor can do, maybe it's time for BERK to distribute some of its cash hoard ...

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