Why This Stock Is a Winner

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If you could wave a magic wand and bestow just one characteristic on all of your investments, what would it be? (Besides the ability to print money, that is.)

I began thinking about this after reading Tom Gardner's A 25-Bagger in Five Years, where he identified three things that give a company the chance to achieve outsized gains over the years -- like 25-baggers that turn $5,000 into $125,000. Of the three he mentions (and actively screens for in Motley Fool Hidden Gems), the characteristic that is most important to me is a high level of insider ownership.

Why it matters
But this makes sense, right? Think about any of your major personal investments:

1. You are a stockholder, with a good deal of your wealth riding on this company's performance.
2. Founders and managers with high levels of ownership also have their wealth riding on the company's performance.
3. They are doing everything they can to increase the long-term value of their stock -- of your stock.

Having a wonderful time ...
With their reputations, their livelihoods, and their careers on the line, you can be fairly sure these managers and board members are motivated to do what's best for the company. It's like having someone on the inside, working for you. Every day.

What is the opposite of that? Businesses where management has very little tied up in company stock. Where actions may be motivated by things that actually harm the stock's performance, like office politics, power plays, or working more with an eye on the clock (is it 5:00 yet?) than on improving the business model. Or, even worse, management that rewards itself with high salaries and bonuses that have nothing to do with outstanding performance.

Now, don't be chagrined if you find that some of your larger holdings have a low percentage of insider ownership. For example, only 1.08% of Cisco Systems (Nasdaq: CSCO) is owned by insiders. IBM (NYSE: IBM) sports 0.06% of insider ownership. Their sheer size makes it awfully tough for anyone to own a significant share of the entire business.

But smaller companies are a much different story. In small-cap land, CEOs and managers with high levels of ownership are much more likely to rise above the mediocrity and work toward the common goal of great stock performance.

For instance ...
I ran a screen for some companies with high insider ownership, but went a bit beyond that. The following businesses also have strong sales and earnings growth, high margins, and high returns on equity -- a potentially winning combination.

Company	Insider Ownership	Sales Growth*	EPS Growth*	Net Margin*	ROE*
Wipro (NYSE: WIT)	82%	32%	29%	19.3%	29.7
First Marblehead (NYSE: FMD)	49%	35%	54%	41.9%	47.3
Global Industries (Nasdaq: GLBL)	24%	47%	118%	10.0%	18.0
Morningstar (Nasdaq: MORN)	73%	29%	135%	16.0%	23.1
LCA-Vision (Nasdaq: LCAV)	27%	43%	48%	16.5%	25.8

*Trailing 12 months. Data provided by Capital IQ, a division of Standard & Poor's.

And beyond ...
Insider ownership, especially in smaller companies, is one positive indicator in the quest for tomorrow's multibaggers. There are many more, of course, but insider ownership is one of the core variables we screen for in Hidden Gems.

The process is working. Tom and his analysts are averaging 32% total returns for their recommendations, compared with 15% for identical amounts invested in the S&P 500. We invite you to take a free trial and look through all of our active recommendations. There's no obligation to subscribe.

This article was originally published on Feb. 21, 2006. It has been updated.

Rex Moore needs more coffee. At the time of publication, he owned no companies mentioned in this article. First Marblehead is a Hidden Gems recommendation. The Fool isinvestors helping investors.