How to Find the Stocks That Will Make You Rich

As measured by my returns over the past six months, I'm a terrible investor. And as measured by their play over the last 15 minutes of their game against Stephen Curry, three referees, and an arena of Davidson fans in the NCAA tournament last March, my beloved Georgetown Hoyas are a terrible basketball team.

But three months of investing matter even less than 15 minutes of basketball. In truth, the Hoyas had a strong year this year, they had three great years before that, and they have Greg Monroe, the nation's top high school player, ready to suit up next year. John Thompson III is building a program for the long term.

As for my investments, I'm building a portfolio for the long term, and current volatility is giving me the opportunity to buy shares of some outrageously cheap stocks.

What works most of the time does not work all of the time
Of course, you could be a wise guy like my dad, who points out that these "outrageously cheap" stocks have only gotten cheaper recently. And that's true.

But since I can't time the market in the short term, I build for the long term.

That means buying stakes in businesses that will grow and profit for decades to come. And if the share prices of these companies fall while the quality of the business remains the same, well, that's a great time to buy more.

Don't get me wrong
Now, if you could time the market, you would have made some incredible money recently. Washington Mutual (NYSE: WM  ) and Bank of America (NYSE: BAC  ) both soared off their lows last week after the government announced support for Fannie Mae and Freddie Mac. If you'd know that was coming, it could have made for some easy money.

Or what if you had succeeded in getting into Philadelphia Consolidated (Nasdaq: PHLY  ) just before it announced it would be acquired by Tokio Marine? That could have made for another good day last Wednesday.

And while there are probably people out there who predicted and profited from these moves, there are others who bet the opposite -- and lost a boatload of money.

In other words, it's impossible to make a career by flipping a coin.

The better way
There is, however, a long list of great investors -- Warren Buffett, Bill Miller, Chuck Akre, et al. -- who have gotten rich by buying stakes in great businesses such as American Express (NYSE: AXP  ) , Time Warner's (NYSE: TWX  ) AOL, and Markel (NYSE: MKL  ) , respectively, and letting those stakes compound for years.

Not only is this a proven and successful investment strategy, but it also has the added benefit of keeping taxes and transaction costs to a minimum.

That makes it an ideal strategy for the individual investor. Yet one nagging question remains: How does one reliably identify great businesses?

The treasure map, courtesy of ... Hahvahd
A recent article from Harvard Business Review and Portfolio.com instructs executives in "10 Ways to Create Shareholder Value." It's an admirable list that every business leader should read. After all, I was shocked to find that "80% of executives would intentionally limit critical R&D spending just to meet quarterly earnings benchmarks."

That kind of short-term focus is the antithesis of a great business, which is why this article isn't just required reading for executives -- it's required reading for investors, too. The 10 ways companies create shareholder value are the 10 traits that outside investors should seek in order to identify great companies.

Great companies focus on the long term, return cash to investors via dividends and buybacks, have leaders with ownership stakes, and file clear, reliable, and transparent documents with the SEC.

It's like looking in a mirror
These are precisely the kind of companies we pick for our Motley Fool Hidden Gems small-cap service, but we include an 11th criterion: valuation. And after nearly five years of recommending stocks, our picks are 20 percentage points ahead of the market on average.

You can take a look at all of our research and recommendations, including our top picks for new money now, by joining Hidden Gems free for 30 days. There is no obligation to subscribe.

This article was first published March 28, 2008. It has been updated.

Tim Hanson does not own shares of any company mentioned. American Express and Markel are Motley Fool Inside Value recommendations. Bank of America is an Income Investor pick. The Fool owns shares of American Express. The Fool's disclosure policy thanks Jon, Roy, Pat, and Tyler for a great run.


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  • Report this Comment On July 28, 2008, at 11:08 AM, HGBG wrote:

    Actually Philadelphia Consolidated [PHLY] was a TMF recommendation in 2000 or 2001 by Bill Mann. If one purchased at that time, the shares would have multiplied 6 to 8 times in value.

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