Invest in the Obvious

Let me tell you about an investing theme that's so obvious in advance, I'm amazed I missed it.

Paper 2.0
The year was 1998, and I saw the exact same thing that should have been clear to anyone who worked in an office: PalmPilots were all the rage.

Having seen Apple (Nasdaq: AAPL) fail in its stated goal to "reinvent personal computing" with its Newton product, I was not in a hurry to invest in 3Com (Nasdaq: COMS), the then-parent company of Palm (Nasdaq: PALM). There were too many companies entering the space, including a monster-to-be in Research In Motion (Nasdaq: RIMM).

No, it wasn't the winner that was obvious to me. The losers, on the other hand ...

Since 1982, DayRunner and Franklin Covey (NYSE: FC) had operated as a virtual duopoly in the personal organizer market. Both operated under a razorblade model: sell the planners and profit on the refills, which needed to be reloaded annually. PDAs nearly instantly made paper-based planners obsolete. These products still exist, of course, and plenty of people use them. But the market for organizers was cored.

My mistake wasn't failing to buy one PDA vendor over another -- my mistake was in not shorting the fire out of DayRunner and Franklin Covey. By 2000, the former was bankrupt, the latter nearly so.

Sometimes the market misses the blatant
Shorting stocks, of course, offers a special challenge for most investors -- if you're wrong, or early, your risk becomes larger and larger as the stock moves against you. The market tends to reward investors the most when they anticipate a trend that is not yet in evidence, but that's also pretty risky. The trend may never come to pass.

Ask people who plowed millions into failed wireless communications provider Metricom about investing in companies too far ahead of the curve. (Or, off the curve, as it were.)

Another way
The market can also undervalue something that seems inevitable. When I selected Chipotle's (NYSE: CMG) B shares for the Motley Fool Hidden Gems small-cap newsletter, pundits (and some colleagues) were calling the shares "pricey." But it was perfectly obvious to me that the market had underestimated just how much growth the company would be able to generate in short order, and that Chipotle's opening expenses had masked its extraordinary operating performance.

What's happened in the intervening year since we invested? Chipotle's shares are up more than 60%, even after the recent volatility.

And speaking of "missing the obvious," bend your mind around this: Chipotle (NYSE: CMG-B) B shares trade at a 20% discount to the A shares but have equal economic value, and 10 times the voting power. Make any sense to you? Think you're missing something? You're not. The market is. Free money.

Grab your own free money
Investing doesn't require brilliance. It does require that you think through what the market is telling you will happen, and take advantage of the places where it's just plain wrong.

Each month, we at Motley Fool Hidden Gems seek out just these kinds of opportunities in the segment where the market misses the obvious the most: Small-cap stocks. If you'd like to join us on the quest, click here for a free trial and you'll have full access to our current list of small-cap recommendations.

Bill Mann puts his pants on both legs at a time. Bill owns shares in Chipotle's B Class shares. Chipotle is a Hidden Gems recommendation; it's also a Rule Breakers selection. Palm is a Motley Fool Stock Advisor recommendation. The Motley Fool has a disclosure policy.