The brilliant business analyst and writer Peter Drucker has made me a lot of money over the years. The 95-year-old dedicated his professional life to an engaging and exhaustive exploration of how organizations succeed and stumble. His insights double as a blueprint to market-beating investing.
I want to share with you a key Druckerian principle that has helped me find some fantastic winners in my small-cap newsletter service, Motley Fool Hidden Gems.
Drucker believes that most people -- and, by extension, most companies -- are terribly unfocused. They have too many loves to satisfy and too few commitments. They dabble here, dally there, and fail to master anything. Peter Lynch, the greatest mutual fund manager of all time, called this phenomenon di-worse-ification. Drucker called it a driver of mediocrity.
So, why do companies diversify?
Loads of public companies actively diversify because, in the short term, all that variety and expansion generates short-term buzz. And during a time when the average CEO stays at a company for just five years, it's not surprising that short-term buzz is a goal.
The long run is won by those who pursue excellence through specialized talents. Take, for example, Vasco Data Security (Nasdaq: VDSI ) . The company maintains a disciplined focus on providing security for computer users.
Despite some volatility during the tech bubble, that focus has helped deliver permanent value to shareholders. Beginning in 1991, the company focused solely on delivering authentication services to financial houses. With expertise in that area and growth across the Internet, Vasco expanded operations across e-commerce but never strayed from its focus on security. Since we identified Vasco on our watch list in 2004, the stock is up more than 60%.
The greatest performer in our Hidden Gems portfolio thus far is Middleby, up more than 250% for subscribers. Today, the company is the leader in commercial ovens for restaurant chains -- but it wasn't always so. In the 1990s, Middleby was picked apart by competition. It was a tiny public company, capitalized at less than $100 million, yet it was trying to win the markets for everything from restaurant deli cases and refrigerators to mixers and blenders to the kitchen sink. The stock was left for dead, selling off more than 50% to below $5.
Then a strange thing happened. Rather than count on expansion to save its hide, Middleby's board of directors installed new management, which aggressively abandoned product lines. CEO Selim Bassoul simply walked away from 25% of the company's sales, choosing to focus all energies on its high-margin commercial ovens. The company's incredible success since that time is another example of the power of focus.
The power of focus
Operational focus is crucial to the success of most every small company in the world. Yet few small-business leaders practice it. In Hidden Gems, it's my goal to help you find the most disciplined companies, poised to become Peter Lynch's next great 10- and 20-baggers. The next monster winner among small caps will be a company as focused as Google (Nasdaq: GOOG ) is with Web searching. But Google's hardly the only example. Think of Coca-Cola (NYSE: KO ) with soft drinks, Chico's (NYSE: CHS ) with sophisticated women's clothing, Whole Foods (Nasdaq: WFMI ) with organic foods, Kimberly-Clark (NYSE: KMB ) with consumer products, or Valero (NYSE: VLO ) with sour crude refining.
Those companies all had the capital to expand into wildly diverse product and service categories (and Coke, for one, temporarily did), but the rewards came when they drilled down into their core business, innovated within a defined space, scavenged for economic efficiencies, and made their stockholders rich. Focus, you see, is how competitive advantages are gained, how defensive moats are carved, how commercial niches are dominated, and how long-term margins of safety are widened for investors.
Foolish final thoughts
The next time you go in search of truly great small-cap stocks, as we do every day in Hidden Gems, remember this Italian proverb:
Often he who does too much does too little.
That's true for each of us, and so, too, with the companies we invest in. If you want to find the next stock to rise 10 times in value, you won't find it glad-handing every new opportunity. Peter Lynch knew that. Peter Drucker wrote about it extensively.
At Hidden Gems, we've found more than 40 focused companies for subscribers. To date, we've achieved 30% average returns and are beating the market by more than 20 percentage points. If you'd like to take a look at our recommendations and interact with thousands of investors who are actively following these companies, click here to take a 30-day free trial. You have no obligation to subscribe.
Heed the words of the masters, and let's beat the market together.
This article was originally published on April 28, 2004. It has been updated.
Fool co-founder Tom Gardner owns shares of Coca-Cola, which is a Motley Fool Inside Value recommendation. The Motley Fool has adisclosure policy.