This weekend, we had the opportunity to attend what may have been the most astounding college basketball game in 25 years, when we watched our hometown George Mason Patriots defeat the mighty University of Connecticut to earn a trip to the Final Four.
Yep, we were there. This was Hoosiers. This was the U.S. hockey team beating the Russians in 1980. This was wrestler Rulon Gardner (no relation to either of us) beating Alexander Karelin. This was Ireland beating England in soccer in 1988. In each of these examples, logic, it seems, was checked at the door. On Sunday, Connecticut's players towered over George Mason's, yet Mason won. And it was not in a lucky-final-shot or a Connecticut-had-an-off-day way. It was a superbly played basketball game. It was a privilege to watch.
As we talked about the game afterward, it occurred to us that there was an investing angle in this "Little School That Could." After all, in the scope of college basketball, George Mason is a small cap. And it's not just a small cap, it's an obscure small cap.
Show your colors
If you can remember, there was controversy over whether George Mason was good enough to be in the tournament. Few expected the Patriots to win one game, much less four. The school wasn't well known. It rarely appeared on TV. And at his house, which is all of 3 miles from Mason's campus, Bill can't even find Mason games on the radio. It's much different from a Connecticut, Duke, or Kansas game, where things statewide seem to come to a halt at tip-off.
In other words, if George Mason were a stock, it could have been purchased dirt cheap. It's a great object lesson in finding hidden value.
Drilling a little deeper, George Mason has several attributes we would want in a small-cap company. Please stick with us through the comparison.
- Talented, long-serving leadership. The college coaching ranks operate in much the same way as the ranks of Corporate America CEOs. Even the poorly qualified leaders tend to be paid well, while good-to-great leaders jump to the next big job and big paycheck in the blink of an eye. By contrast, Mason's coach, Jim Larranaga, is in his ninth year with the Patriots, having coached 11 years at his previous job. It's not that he hasn't jumped at big job opportunities; it's more that he never seems interested in them. Many great small-cap companies have similar CEOs dedicated to the companies they lead -- Jim Sinegal at Costco (Nasdaq: COST ) , Leigh Abrams at Drew Industries (NYSE: DW ) , and Decker Dawson of Dawson Geophysical (Nasdaq: DWSN ) . All are long-serving executives who have led no-nonsense companies for successful stretches.
- Underrated excellence. Anyone who watched the game would say that these teams were evenly matched. That wouldn't be noteworthy, except that Mason was totally unknown, while Connecticut was largely believed to be the best team -- and certainly one of the most closely followed -- in the country. The lesson is that people overvalue what they know and undervalue what they don't. This is why a visible stock such as KrispyKreme (NYSE: KKD ) received huge levels of attention and adulation while more obscure (and, as it turns out, better-run) companies like foreign retailer ControladoraComercial Mexicana (NYSE: MCM ) are almost never discussed.
- Low expectations. This is one of the most interesting parallels. If George Mason and Connecticut were stocks, one would expect Connecticut to trade at a much higher valuation. Why? Well, it was expected to win. George Mason was expected to lose. In fact, George Mason had never won a single NCAA tournament game in the history of its program. But part of the investing process is to look for companies that the market does not expect to win but actually have a reasonable chance of doing just that.
For example, several years ago we wrote about refinery company Valero (NYSE: VLO ) for the predecessor publication to our Hidden Gems newsletter. Valero is a refining company. Not only was refining considered unhip, but Valero also competed against some of the biggest companies in the world -- for example, ExxonMobil (NYSE: XOM ) , which has the largest market cap in the world. But we noticed that because refining is capacity-constrained, and because Valero had spent the money to convert its refineries to be able to handle lower-grade "sour" crude oil, it had an absolute advantage in a business that had excellent potential. Since that time, Valero has increased in value more than eight times. It was unloved, unknown, underappreciated; it was bad to the bone.
Getting on the radar
This is not to say that a company playing a Connecticut-like team -- let's use Google (Nasdaq: GOOG ) as an example -- is necessarily a bad investment just because expectations are high. And this is not to say that anything with low expectations is a great opportunity. But a company that the market expects a lot from must perform well to maintain its valuation, while a company that the market ignores can generate respectable investment gains simply by getting on the radar.
In the end, that's what George Mason has done -- it has outperformed even the most optimistic expectations for what the team could do.
Basketball-as-investing metaphors break down after a while. The reality is that a basketball game has a defined winner and a defined loser, whereas investing is a longer process. But the mixture of low expectations and high potential has conspired to spark a dream run for the George Mason Patriots. That's what we look for in our stocks, and that's why we proudly designate GMU to be a bona fide Hidden Gem.
And no, we still can't believe what we watched.
How about that? A column about college basketball and investing that didn't include discussion of "brackets." Tom Gardner -- co-founder of the Motley Fool -- and Bill Mann are advisors at the Motley Fool Hidden Gems small-cap newsletter service. You can view all their buy reports for free by taking ano-obligation 30-day free trial. Tom does not own shares of any company mentioned in this article. Bill owns shares of Costco, which is a Motley Fool Stock Advisor pick. The Fool has a strictdisclosure policy.