245 Incredible Companies

The 10 best-performing stocks of the past decade were obscure, ignored, and small. But what about the top 25? The top 50? The top 100?

It turns out that most of the stock market's greatest performers of the past 10 years were also obscure, ignored, and small.

Small stocks for big returns
From January 1998 through December 2007, 245 stocks on our domestic exchanges could have earned you greater than 20% annualized returns over the past 10 years -- turning a $10,000 initial investment into more than $60,000. Of those 245 stocks, 224 of them were small caps 10 years ago. That's more than 91%. While the companies run the gamut from now-giant pharmaceutical company Allergan (NYSE: AGN) to commercial oven maker Middleby, the common thread is size.

Ten years ago, Middleby was worth only $82 million. Today, it's valued at more than $1.0 billion -- having taken shareholders along for a very rewarding ride.

And Middleby, for one, is still growing. The company dominates its niche and has almost every trait investors should look for in a small cap: superior leadership; clear, competitive advantages; and impressive and improving returns on equity and assets. Since we recommended it in our Motley Fool Hidden Gems small-cap investing service, it has also returned nearly 600% for our members -- but we're confident that it will keep on performing over the long term.

Big stocks for smaller returns
Only 21 mid- or large-cap companies would have given you the same growth; this small group includes includes Exelon (NYSE: EXC), Stryker (NYSE: SYK), and Apache (NYSE: APA). And while the returns have been incredible from these two companies -- both of which demonstrated some key traits of great small caps -- they're just not as prevalent as the small guys.

That's because it's difficult for larger companies to generate the same kind of growth as small caps. While Middleby grew from an $82 million market cap, Exelon grew from a $5.4 billion base and is now worth $51 billion.

Exelon added substantially more value in absolute terms, but the story changes when it comes to stock prices and percentages. Middleby stock returned more than 1,800%; Exelon returned 573%. Now compare that with a much larger company, such as Hewlett-Packard (NYSE: HPQ) or PepsiCo (NYSE: PEP). These giants added $65 billion and $67 billion, respectively, to their market caps during the same 10-year span, yet investors gained only 82% and 145% (including dividends!). That's a consequence of the Law of Diminishing Returns, and it's a simple and crucial point in investing.

The Foolish conclusion
Small caps are one area of the market where individual investors have the opportunity to earn phenomenal returns -- but there are also pitfalls. For each of the 224 small caps that could have earned you greater than 20% annualized returns over the past 10 years, quite a few more didn't make it. Small-cap stocks tend to carry far more risk than large caps do, so investors must consider their investments very carefully.

That's why we advocate a diversified portfolio of select small caps for Hidden Gems subscribers. By focusing on factors such as superior management and a strong balance sheet and enjoying the benefits of diversification, our small-cap recommendations have outperformed the market by more than 21 percentage points since we started.

Every investor should have at least some smart exposure to small caps, because the historical profits are just too good to pass up. If you'd like some help getting started in this incredible area of the market, click to join our community free for 30 days.

This article was originally published on Feb. 6, 2006, as "325 Incredible Returns." It has been updated.

Tim Hanson does not own shares of any company mentioned. No Fool is too cool for disclosure.