Why Follow the Market When You Can Lead It?

Bloomberg, we have a problem.

There's a problem with the Bloomberg Businessweek 50, a list that culls the S&P 500 to come up with the 50 best performing stocks over the past five years. Like a camembert-topped snow cone, it stinks at the top.

Let's go over the five best performers on the list, and see if you can catch a whiff of what I'm smelling.

*Through March 31, 2010.

These are some pretty heady gains, especially compared to the S&P 500, which essentially ran in place during those same five years. However, it's not as if someone who plunked down money into an S&P 500 got in on these beefy runs -- and it has nothing to do with the 495 laggard components watering down the octane of these five speedsters.

See, with the exception of Apple, these stocks weren't even in the S&P 500 five years ago. Intuitive Surgical, priceline.com, Southwestern, and salesforce.com were all added to the index during the spring and summer of 2008, well into their meteoric runs.

This Bloomberg gauge, sadly, is a big bowl of revisionist history.

Be fashionably early
I don't have a beef with the S&P 500. It's a decent place to be for those who want to ride a basket of our country's largest stocks. Whether one seeks instant diversification, is dry on ideas, or just needs a market placeholder, the S&P 500 isn't the most duplicated index fund by mutual fund operators by accident.

However, why be the market when you can beat the market?

When priceline.com was tapped for the S&P 500 on August 1, 2008, less than two years ago, it had already validated itself as a market-thumping travel portal. It certainly served the S&P 500 well, and has gone on to roughly double since its index debut at $116.66. But the 10-bagger prize over the past five years that the Bloomberg Businessweek 50 is promoting is reserved for those who got in three years earlier.

Intuitive Surgical provides an even more compelling contrast. The maker of the da Vinci surgical system, a robotic arm revolutionizing the operating table, was already perched at $293.59 when it was added at the end of May in 2008. It only went on to tack a mere 19% gain in the S&P 500 through the end of March this year, a far cry from its speed demon return of 666% over the five previous years.

As the two star pupils of the Bloomberg Businessweek 50, the obvious lesson here is to buy into the winners before the S&P 500 hands out induction notices.

Easier said than done? Perhaps, but isn't this essentially what David Gardner did? He got in on both stocks, long before indexing validation.

A tale of two speedsters
David recommended priceline.com to Motley Fool Stock Advisor subscribers in May 2004, at a lower price point than the starting line used for the five-year return of the asterisk-worthy Bloomberg index. A year later, he singled out Intuitive Surgical for the Motley Fool Rule Breakers newsletter service, just as it was starting to turn heads.

It's not really a surprise to find that both newsletter services have gone on to handily beat the market over the years. These aren't even the biggest winners in their respective newsletters.

How is it that David spotted tomorrow's winners several years before the S&P 500 itself started to pay attention? Well, in the metric's defense, it never could have bought in even if it wanted to.

The S&P 500 has a few requirements that limit its performance. It is restricted to stateside companies, shutting out participants from faster-moving economies overseas. China's Baidu (Nasdaq: BIDU), the leading search engine in the world's most populous nation, is currently the best performer in Motley Fool Rule Breakers.

However, the primary roadblock that would have kept priceline.com and Intuitive Surgical out of the S&P 500 when David was dusting them off for his newsletters is that the index currently demands a market cap of at least $3.5 billion for consideration. Intuitive Surgical commanded a value of $1.6 billion when David issued his initial recommendation, and priceline.com clocked in even lower at $875 million.

It's understandable, for indexing purposes. The S&P 500 wants 500 of the largest domestic companies as constituents. However, it also eliminates a lot of the money that is waiting to be made on the way there.

Sirius XM Radio (Nasdaq: SIRI) would make the market cap cut today, but the satellite radio provider would fall well short when it bottomed out 17 months ago before its meteoric 20-fold run.

This is why it may be easier to beat the market than you think. There are great stocks that the S&P 500 can't add. There are fast-growing companies that are too small for Warren Buffett to meaningfully buy into.

There will naturally be amplified risks on the downside, too, but the first step in beating the market is to stay one step -- or in this case several years -- ahead.

Have you taken a chance on a stock that trounced the market because you bought in early? Share your success stories in the comment box below.