Big Winners for Small Investors

There's a billionaire in the Midwest who boasts he can earn you 50% profits year after year on a portfolio of ordinary common stocks. Of course, there's a condition.

Or maybe that's just a Wall Street legend. After all, it's been debated for years. Did this guy really make that audacious claim? And if so, what was that one condition?

Enter a flock of Jayhawks
While we bickered over who said what and when, a bunch of meddling kids actually did something about it. They kicked their way across Kansas and set up a meeting.

And they asked him: Did the guru known as the world's greatest living investor really make that "50% per year" guarantee? And more important, would he stand by it today? As it turns out, he didn't just confirm it was true -- he went a giant step further.

You'll be surprised how he would do it
To earn you 50% per year -- essentially doubling your money every 20.5 months -- this guy wouldn't buy the blue-chip consumer giants that made him a legend ... or even his own $210 billion company.

No, he'd buy obscure outfits with names you've never heard of. How do I know? He told us. Remember that one condition?

Well, this fellow would guarantee us 50% per year ... only if we had less than $1 million to invest. That's because he would be loading up on undiscovered, thinly traded small caps -- the one spot in the market where individual investors like us have an advantage over the pros.

Why Warren Buffett wishes he were you
You knew it was Buffett, didn't you? Well, can you guess why he wishes he were you? Because he has too much money. I know, that sounds nuts. After all, the big money on Wall Street has all the advantages, right? Wrong.

For one thing, most pros have way more than $1 million to invest, so they can't mess with great small companies -- at least not without risking running up the price or inadvertently buying a controlling stake in the firm.

That's one reason why you see so much trading volume in the usual suspects. Take a look at these names among the most widely owned Nasdaq stocks.

And over on the NYSE? How about Wells Fargo (NYSE: WFC) and JPMorgan Chase  (NYSE: JPM), each weighing in at more than $100 billion and trading more than 30 million shares a day. On Wall Street, they call this liquidity -- a polite way of saying "the usual suspects buying and selling the same old stocks to each other."

So, if you've got half a billion to put to work this afternoon, you'd better buy something big and forget about the next big thing. But don't expect to be dazzled; those usual suspects don't have many doubles left in the tank -- much less one every 20 months or so.

Wait a minute! Aren't small companies risky?
Not necessarily. Ibbotson Associates tracks stock returns by "style" and market cap. You could have invested $1,000 in Ibbotson's large-cap universe back in 1927, and you'd have about $2 million today. Not bad.

If you'd bought small-cap value stocks instead, you'd have $33 million. Of course, the word "value" here is critical. In fact, combining small-cap potential with old-school value is the missing link between big profit potential and Warren Buffett's grind-it-out success.

Motley Fool co-founder Tom Gardner hammered this lesson into my head back when I worked with him on his Motley Fool Hidden Gems newsletter. So, as you'll see for yourself in a moment, I know firsthand how dramatic the returns can be when you focus on unloved, obscure, and (most important) underpriced small companies.

"Be greedy when others are fearful"
That's something else I heard from Buffett. If you ask me, the market volatility and rotation into mega caps is great for small-cap investors like us. It's a value investor's dream. In other words, if you've ever wondered how Tom Gardner has beaten the market five years running with small-cap value stocks -- and wanted to join him -- now's the time.

Especially since you can give Hidden Gems a try for free for a full month, and get Tom's top five picks for new money right now. I have a hunch that Hidden Gems can help make you some money. I guarantee it'll make you a better investor. If you have less than $1 million to invest, that is.

Best of all, there's no risk. If you're not absolutely convinced at any point during the first 30 days, I'll personally make sure Tom doesn't charge you a dime. Buffett would be proud. To learn more about this free trial offer, click here.

This article was originally published on Feb. 10, 2006. It has been updated.

Paul Elliott promises to keep you posted on Tom Gardner's results. As of this morning, the stocks highlighted in Hidden Gems are up an average of 33.8%, versus 11.8% if you'd bought the S&P 500 instead. You can view the entire scorecard with your free trial. Paul doesn't own any stocks mentioned. NVIDIA is a Motley Fool Stock Advisor recommendation. JPMorgan is an Income Investor selection. The Fool has a disclosure policy.