Strategies and Tactics for Finding Winning Stocks

There are nearly 7,000 stocks on the U.S. markets. Depending on your perspective, that's either a lot or not very many. Some of these companies are massive and well-known, like megaretailer Wal-Mart. Others are obscure, like moissanite manufacturer Charles & Colvard. What's moissanite, you ask? Our point exactly.

Having this many choices is both a boon and a curse. After all, an enormously diverse set of companies means you're bound to find something the market has missed. On the other hand, you can't possibly analyze and track 7,000 companies, so these opportunities are difficult to find. We're about to reveal our process for finding the big winners. It involves strategy. And tactics. And coffee.

And then more coffee
At Hidden Gems, we use "Strategy and Tactics meetings" to solve even the most mundane of tasks -- you know, things like, "Want to go to Starbucks?" (a problem with a fairly straightforward solution). But the other day, we were reminded of the relative importance of strategy, as opposed to tactics, in investing, and how most coverage of the market gets the weighting of these two things completely wrong. This revelation did, in fact, require coffee.

Winning in the market, strategically
Let's turn to Wikipedia for a quick review of our word of the day: strategy.

Strategy is a long-term plan of action designed to achieve a particular goal, most often 'winning.' Strategy is differentiated from tactics or immediately actions with resources at hand by its nature of being extensively premeditated, and often practically rehearsed. Strategies are used to make the problem easier to understand and solve.

This strikes us as a perfectly valid way to view investing. Instead, the mainstream media tends to focus to an unbelievable degree on the tactics of investing -- and presents the market as an incomprehensibly difficult set of problems to comprehend and solve. What stocks should we all buy today? What to sell now? What effects does the biggest news have on the market and on other stocks? Should I buy Flotz Industries shares because I anticipate that it will beat analyst estimates?

It's hard to tell whether most of this discussion even includes the tactics of investing, but it certainly has nothing to do with strategy. It's like trying to drive to Memphis by getting directions to your nearest gas station. Then, when you get there, you ask for directions to the next gas station, and so on, until you finally reach someplace that is almost certainly not Memphis.

News matters, but not the way you think
Of course, every day there's some sort big news that affects the market. Last week, it was the word that Microsoft (Nasdaq: MSFT  ) was abandoning (for the moment at least) its pursuit of Yahoo! (Nasdaq: YHOO  ) . The announcement that American International Group (NYSE: AIG  ) was in far worse condition than it had let on. Or speculation about what today's price for a barrel of oil (versus yesterday's) would mean for ExxonMobil (NYSE: XOM  ) and Chevron (NYSE: CVX  ) .

The headlines in each case were bandied about in their expanded forms. How should investors play each piece of news? What might it mean for the future of search on the Internet, or the present state of the credit crunch?

These things matter, but they're far less important than the media and investors believe. In fact, we'll go a step further: You should largely ignore the most recent pieces of news.

After all, do we care at all today that in 2003 Costco (Nasdaq: COST  ) missed earnings? Of course not. And the returns for people who held Costco through those dark days have been huge. We advise adopting just a very few aspects of a completely nutritious investing strategy.

Let's make this problem easy to solve
To a large extent, a successful investing strategy revolves around a remarkably simple approach: Buying undervalued securities, holding them for long periods of time, turning over the components of a portfolio infrequently, not overreacting to the latest headline, and not trying to time the market.

That's about it. You can find plenty of data to support that short story. (It often comes in the form of Warren Buffett's biography, or Philip Fisher's.) And as far as a core investment strategy goes, you can accomplish virtually all of it by buying and holding a low-cost index fund such as Vanguard's Total Stock Market Index (FUND: VTSMX  ) , or an exchange-traded fund that covers the broad market.

In addition to that basic plan, we concentrate our efforts on individual small-cap stocks, which outperform large-cap stocks significantly over the long term. And we put a concentration on finding attractive long-term opportunities at the right value, which is a good deal of the work of intelligent strategic investing beyond buying and holding an index fund. We have yet to find a headline that helps us assess the long-term intrinsic value of a company.

What has worked for us best is finding companies that are almost never in the headlines. Oven makers, manufacturers of nasal strips, and funeral-home operators are typical of the 18 recommendations in Hidden Gems that have more than doubled. They're the type of companies that infrequently (if ever) get the temporary burst of media coverage that accompanies high-profile, less profitable, but more frequently traded stocks.

So, as we look for the next four-, five-, or six-bagger, we'll continue to ignore the headlines. Our strategy, and hopefully yours, will be to keep an investing style constant, focus on value, and find it where others aren't looking. You can join us in that search with a free 30-day trial of Hidden Gems any time you're interested. We hope to see you there.

Bill Mann owns shares in Costco, as well as a five-gallon jar of capers. Bill Barker does not own stock in any companies mentioned in this article. Costco is a Stock Advisor recommendation. Wal-Mart and Microsoft are Inside Value selections. The Motley Fool has a disclosure policy.


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