Stop me if you've heard this one. The one stock you must buy is ... the next Microsoft (Nasdaq: MSFT ) , the next Wal-Mart (NYSE: WMT ) , the next Adobe (Nasdaq: ADBE ) , and the next Dell (Nasdaq: DELL ) all rolled into one.
That's a pitch I'm sure you've heard some semblance of at cocktail parties, golf outings, weddings, and, of course, on the Internet.
And it's a pretty appealing pitch. After all, Microsoft, Wal-Mart, Adobe, and Dell are some of the stock market's greatest success stories. These companies have earned early investors simply mind-boggling 20,000% to 100,000% returns.
The secrets of success
So the question is: Does that one stock you must buy exist? Of course it does. But can you find it? That's a different matter.
Here, however, is a litmus test to gauge every stock tip you come across. Simply ask: Does this company bear any resemblance at all to Microsoft, Wal-Mart, Adobe, and Dell before they were big names?
That's not to say that one stock will be a discount retailer or a tech superstar. Rather, Microsoft, Wal-Mart, Adobe, and Dell all share a set of remarkable traits that characterized them when their remarkable stock market runs began. All were:
Led by a dedicated founder.
Profiting from a wide market opportunity.
If the next stock that's pitched to you doesn't possess these traits, then you're probably better off passing.
A case study
Consider, for example, the cases of Sirius Satellite Radio (Nasdaq: SIRI ) and XM Satellite Radio (Nasdaq: XMSR ) -- the two stocks that are most often pitched to me at cocktail parties, golf outings, weddings, and of course, on the Internet.
Are they small? No. Sirius is capitalized at $4.2 billion; XM at $3.5 billion.
Are they led by dedicated founders? No. Neither Mel Karmazin nor Hugh Panero founded their respective companies.
Are they fiscally conservative? No. Neither company is currently profitable, and both carry heavy debt loads.
Do they have wide market opportunities? No. Folks may disagree with me here, but I think most people who want to listen to music and news already have a way to do it.
The Foolish final word
I'm not here to be negative about either Sirius or XM. The companies could merge and make for good investments going forward. I don't, however, think either possesses the core traits that made companies like Microsoft, Wal-Mart, Adobe, and Dell such incredible investments and that we look for at our Motley Fool Hidden Gems small-cap investing service.
Again, we believe that tomorrow's big winners will start off:
- Led by a dedicated founder.
- Fiscally conservative.
- Profiting from a wide market opportunity.
If you'd like to take a look at the companies we've found that meet the four criteria mentioned above and have put our service 35 percentage points ahead of the S&P 500 since 2003, click here to join Hidden Gems free for 30 days.
This article was first published on Oct. 19, 2006. It has been updated.
Tim Hanson does not own shares of any company mentioned. Microsoft, Dell, and Wal-Mart are Inside Value recommendations. Dell is also a Stock Advisor recommendation. The Fool's disclosure policy assures you that no stocks were harmed in the penning of this article.