What the Best Investors Own

One thing that many investors look for to confirm that they own a good company is institutional ownership. This is the percentage of shares that are owned by institutions: mutual funds, hedge funds, pensions, and so on. The theory is that the professionals who run these funds are highly knowledgeable investors, who have done high levels of research and are unlikely to make a mistake.

It's a nice theory. It's garbage, but it's a nice theory.

When it works
But there are two things that do interest me. First, as a negative, if you see a company that has minimal institutional interest (or, more likely these days, institutional interest that primarily comes from indexers), then I am pretty sure that there's something deeply wrong with the company.

Let me give you an example: Institutions own approximately 5% of Research Frontiers (Nasdaq: REFR  ) , a revenue-impaired "smart window" company with a $160 million market capitalization. Further inspection shows the largest two institutional holders, Vanguard Group and Barclays, are indexing companies and likely do not have much opinion at all on the quality of this company.

By the same token, companies with extremely high institutional ownership are most likely well known on Wall Street (sort of an obvious statement) and aren't as likely to offer as much value. The mathematical approach here doesn't make much sense. What does make sense is a study of what the best investors own. This doesn't mean that you run out and buy blindly when Warren Buffett buys, but let's face facts -- if you had bought PetroChina (NYSE: PTR  ) when it became known that the Oracle of Omaha did, you're sitting on some enormous gains right now.

Beyond Buffett
The thing is, Buffett may be at the top of that list, but he's not the only brilliant investor out there. Leon Cooperman filed that his fund (Omega Advisors) has bought 6% of Resource America (Nasdaq: REXI  ) , a small-cap asset manager based in Philadelphia. I'm fascinated by that. And that the brilliant investors at Southeastern Asset Management, run by Mason Hawkins, now own -- get this -- nearly 21% of controversial Canadian insurance company Fairfax Financial Holdings (NYSE: FFH  ) . And that Ron Muhlenkamp, manager of the eponymous Muhlenkamp (MUHLX) fund, recently disclosed that he had bought more than 7% of Motley Fool Hidden Gems recommendation Stanley Furniture (Nasdaq: STLY  ) .

If you're an owner of CrosstexEnergy (Nasdaq: XTXI  ) , you should like seeing that Chieftain Capital Management has a big stake. Thomas Stern runs a highly concentrated portfolio, which at present contains eight names, so the research that goes into each one is typically obsessive. Just the same, noted value-curmudgeon Seth Klarman has maintained The Baupost Group's stake in development-stage specialty drug firm Acusphere (Nasdaq: ACUS  ) as management stumbles its way toward seeking approval for its ultrasound contrast agent, Imagify, toward a hoped-for FDA approval later this year.

Does the ownership by these best-of-class investors spell certain glory for shareholders in these companies? Certainly not. Many of us watched in amazement as Mason Hawkins and his gang defended their position in packaged-goods company Fleming back in 2002 as it roared its way straight into bankruptcy. No, the contrarians are sometimes very, very wrong. But seeing some of the best and the brightest holding -- and buying -- companies you own is a pretty good sign.

The Foolish bottom line
Finding holdings of the great investors -- many of whom the average investor has little knowledge of -- is a tried and true way of seeking out good stock ideas.

Of course, if you're looking for a good few ideas each month, you can also join Fool co-founder Tom Gardner and me as we turn over rocks, stones, and the occasional yak to find the world's great small-cap companies. A free 30-day guest pass to Motley Fool Hidden Gems is yours with my compliments. Just click here for more information.

Bill Mann is worried that he won't be able to speak Chinese after the operation. Of course, he doesn't speak Chinese now ... and there's no operation. He holds shares in Acusphere. Muhlenkamp is a Motley Fool Champion Funds recommendation. The Motley Fool has a disclosure policy.