Get Ready to Buy

• Email
• Share
• Print

"Over the years, small-cap stocks crush their large- and mid-cap peers."

That's how I planned to open today. Heck, I'd be making my case by now -- dropping names like Nagel and Quigley (what the who?) and 70 years' worth of data from Ibbotson.

But you're no dummy
And by now my inbox would be bursting. "Your results are skewed by abnormal years!" you'd be shouting, or "What about survivorship bias?" And you would be right. You would have found the fatal flaw in all historical data: The future is not the past.

So forget the big numbers
Fortunately, you don't need a big Excel spreadsheet to prove that tomorrow's big winners are small caps today. You just need these three clues. After all, it's a pretty safe bet that tomorrow's Google (Nasdaq: GOOG) -- heck, even tomorrow's General Electric (NYSE: GE) -- is ...

1. Run by entrepreneurial zealots with ownership stakes.
2. Free of convoluted relationships with investment banks.
3. Able to grow its sales and cash flow exponentially.

And because it's off Wall Street's radar (for now), there will be pent-up demand when those revenues rocket and analysts catch on.

Getting in on the ground floor
My father always told me to "be your own boss and die rich." He had a point. Sure, folks cashed in on Wal-Mart (NYSE: WMT) and took a juicy bite out of Apple (Nasdaq: AAPL), but did they do so well as their first investors, Sam Walton and Steve Jobs?

Hardly. Of course, this is the oldest story ever told. The Rockefellers still have the money, and the nearer you got to old Henry, the sweeter your investment in Ford.

And if it's true that few of us build empires or even place venture capital, that doesn't mean we can't get in early. We just need to be patient and pick our spots. Or take a cue from Tom Gardner'sMotley Fool Hidden Gems method and purposely seek out upstart companies with market caps below $2 billion offering:

1. Solid management with big stakes.
2. Great, sustainable businesses.
3. Dominant positions in niche markets.
4. Sterling balance sheets.
5. Strong free cash flow.

Remember those five keys
In the '90s, they led folks straight to Intel (Nasdaq: INTC) and Schwab (NYSE: SCH) -- and to ridiculous gains. Years before, they brought our parents to Disney (NYSE: DIS). In just the past 24 months or so, they've led the Hidden Gems gang to a half-dozen stocks that doubled in value or more.

This is especially important in today's up-and-down market, because the next pullback could be your chance. But to strike when the iron's hot, you need a wish list of great small companies to buy. I have mine right here.

If you need some help putting yours together, Tom Gardner is offering a 30-day free trial to Hidden Gems. It could be the thing for you. Of course, there is no obligation or pressure to subscribe. Click here to learn more.

This article was originally published on May 10, 2005. It has been updated.

Paul Elliott promised to keep you posted on Tom Gardner's progress. As of Nov. 4, 2005, the Hidden Gems recommendations are up 27.3%, compared with 8.6% if you'd bought the S&P 500. He no longer owns (sadly) any of the stocks mentioned here. Schwab is a Motley Fool Stock Advisor recommendation. The Motley Fool has adisclosure policy.