3 Winners You Don't Know About

It's time once again to play the role of lab rat and win some cheese: Which investment yielded the biggest gain over the past five years?

1. Leading computer maker Dell (Nasdaq: DELL)?
2. XM Satellite Radio (Nasdaq: XMSR)?
3. Or heavy-machinery maker Caterpillar (NYSE: CAT)?

If you answered Dell or XM, you get a mild electric shock and a trip back to the cage. If you sensed a trick question or happened to be the astute investor who picked Caterpillar, a nice chunk of cheddar awaits.

Blowout returns for the boring
Selling construction and mining equipment has been good for Caterpillar and its investors. The stock has returned a whopping 275% -- or 30.2% compound annual growth -- over the past five years.

Meanwhile, even commanding a top brand in computers hasn't helped Dell grow cash flow enough to keep the stock rising. The result there is a meager 0.5% gain.

And while it's handily beat the S&P since the pessimism surrounding satellite radio in 2002, XM's returns still fall short of Caterpillar. Stock in XM has risen 128% over the past five years.

Examining five-year returns is purely backward-looking, of course. My point is that the most popular stocks aren't necessarily the best investments. Often, investors equate popularity and glamour with momentum and growth. This mindset can backfire, because stock popularity often makes shares outrageously expensive, leaving even good companies vulnerable to painful downturns.

Sniffing out the good cheese
The notion that investors have a better chance of finding killer stocks where few people go looking is not new. Though it seems to be seldom practiced, I hear it preached a lot from Fool co-founder Tom Gardner and longtime Fool analyst Bill Mann. In their Motley Fool Hidden Gems small-cap service, the duo has singled out several big winners operating in mundane yet profitable niches such as insurance, mattresses, and paper pulp.

And if you're still not convinced that there's big money in the boring, here are three more examples to get you going.

1. Iconix Brand Group (Nasdaq: ICON) is a little-known brand-licensing firm that's behind a few well-known products such as Joe Boxer, Mossimo, and London Fog. Similar to competitor Cherokee, the company keeps margins sky-high and costs low by purposefully staying out of the manufacturing business, instead focusing on the licensing and marketing of brands it owns.

In the last five years, Iconix has returned an amazing 550% -- a compound annual growth of nearly 46%. The company is relatively small, with a $1.2 billion market capitalization, and it's taking on more debt -- via a recent $287.5 million convertible note offering -- to pursue more brand deals. While buying brands may sound like a boring business, it has generated exciting profits.

2. Alderwoods Group was proof that there's profit in the morose. Not many investors would look into one of the leading funeral-service providers for big gains, but before being acquired by Service Corp. (NYSE: SCI), Alderwoods was a textbook turnaround story. Since coming out of bankruptcy in 2002, an experienced management team methodically paid down debt and increased revenue and profits.

Investors who bought the Hidden Gems pick in October 2003 and took the $20-per-share cash offer earned a return of more than 191%, much more than most would expect from a boring industry such as death care.

3. Smith Micro Software (Nasdaq: SMSI) is a $435 million company that sells innovative software tools and mobile communications solutions. Many new products are sold on an OEM basis, in which a wireless carrier integrates Smith Micro's connectivity software into its offering of mobile devices and services.

Rapid revenue and earnings growth, fueled by successful product launches, has provided big gains for investors. The little-known software company has returned an amazing 2,800% over the past five years. One significant concern, however, lies in revenue concentration on a few products and customers. For instance, Verizon accounted for nearly 60% of Smith Micro's revenue in the most recent quarter.

Get in the know
Little-known, well-run companies such as Alderwoods Group (selected twice in Hidden Gems) and petroleum-products supply-chain manager TransMontaigne -- a Bill Mann Hidden Gems pick that returned more than 60% in seven months before being acquired -- can do wonders for your portfolio. Go hunting for them in the market's more mundane sectors, and you can get boring to work for you.

If you'd like a little help getting started, click here to join Hidden Gems free for 30 days and check out the entire lineup of small-cap stock recommendations.

This article was originally published on June 27, 2006. It has been updated.

Fool contributor Dave Mock runs the rat race every day, but he rarely gets the cheese. He owns no shares of companies mentioned here. The longtime Fool is also the author of The Qualcomm Equation. Dell is an Inside Value and Stock Advisor recommendation. The Motley Fool has a disclosure policy.