The month is October. The year is 1988. As the underdog Los Angeles Dodgers are shocking the Oakland A's in the World Series, Progressive is trading at $24. Adjusted for splits and dividends, that's around $0.55 per share.
Exactly 20 years later, with the Phillies and the Rays battling in another World Series, Progressive sits around $13. In other words, it's been more than a 22-bagger over the past 20 years, turning a $5,000 investment into $117,000 despite a recent drop in the price.
We believe there are several lessons to be drawn from the Progressive story that will help your future investing performance -- lessons that have helped our own strong performance in Motley Fool Hidden Gems. I'd like to share them with you today.
1. The power of patience
Meaningful gains do not happen overnight, of course. In late 1988, George Bush had just won the presidential election. George H.W. Bush, that is -- the current president's father. That's certainly not ancient history, but the point is that it took 20 years for Progressive to increase 22 times in value. Time and patience are two of the most important factors in investing, and they can help overcome mediocre performance thanks to the power of compounding returns.
Consider that a person contributing $2,500 yearly to an IRA and earning an excellent average annual return of 15% will accumulate about $116,000 after 14 years. Yet someone who started investing just four years earlier will just about reach the same total by earning an average return of only 10%. The important thing is to simply get in the game as soon as you can; then, once you're in, hurry up and be patient.
2. Small is big
Back before it started its run, Progressive was valued at just $300 million -- a small cap by any measure. Today's future 20-baggers will also be small companies. They will not carry Goldman Sachs' (NYSE: GS ) $36 billion market cap, for example. While Goldman Sachs may very well provide solid returns over the next few years, its size will limit it from achieving more jaw-dropping gains. Progressive itself can't even be the next Progressive, because it now sports a $9 billion market cap -- not nearly as big as Goldman Sachs, but still too big to achieve supersized gains.
Small companies offer individual investors like us many other advantages. Most institutional investors, who have billions of dollars to allocate, must avoid small caps, at least until they grow larger. That makes these companies underfollowed and increases the chances that they're misvalued. To see why, consider an analogy we've used before.
The less activity in a marketplace or auction house, the higher the probability of pricing inefficiencies. When there is only one bidder for an autographed Michael Jordan game jersey, the chances for mispricing are infinitely higher than when thousands of investors bid every day -- every hour -- on the present price of, say, Newmont Mining (NYSE: NEM ) stock, which trades about 10 million shares each day. That inefficiency provides opportunity for us smaller investors.
3. A penny shaved
Progressive was never a penny stock trading below $1 per share. Future 10- and 100-baggers are most often trading between $5 and $50 per share (at least, the ones we care about). They are rarely below $5, and they certainly aren't below $1.
Penny stocks represent ultra-tiny companies whose shares can easily be manipulated by unscrupulous people misrepresenting the businesses' true potential. In short, stay away from stocks that aren't traded on one of the major U.S. markets (the New York Stock Exchange, Nasdaq, or American Stock Exchange), or that have no revenues, or that are obviously being hyped via email or discussion boards. You'll save yourself a ton of grief.
4. Dandy dividends
In our research, we're constantly studying past big winners to find the common ties that bind them. Oil and gas explorer XTO Energy (NYSE: XTO ) , beverage king Pepsi (NYSE: PEP ) , and drugstore giant CVS Caremark (NYSE: CVS ) all have different business models and capital structures. All, however, have trounced the market over the years, and all paid a dividend even as small companies.
But a company that's small and pays a dividend isn't necessarily destined for greatness. But a dividend is a positive indicator, a telling sign of both financial strength and management's confidence that the company will continue to be solid through good times and bad. Progressive began paying its dividend back in 1986, when it was still capitalized at around $250 million.
In any company we research, we believe it's extremely important that management's interests are aligned with those of shareholders. While investors want to see their shares outperform over the years, managers who are indifferent to the stock price may be more interested in hiring friends and grabbing perks than creating value. Enron, WorldCom ... the list of corporate disappointments is too long to go into here.
That's why we love to see strong insider ownership at a company. Google (Nasdaq: GOOG ) founders Larry Page and Sergey Brin own about 18% of their business. Peter Lewis, Progressive's chairman and founder, still owns more than 7% of the company. His stake is worth close to $565 million today. If you want to talk about leadership with a vested interest in a business's long-term success, these are perfect examples.
6. Boring excitement
So a world-class company like Progressive must be headquartered in New York, right? Or Hartford, Conn., the "Insurance Capital of America"? Nope. It hails from Mayfield Village, Ohio, in the eastern suburbs of Cuyahoga County, approximately 20 miles from downtown Cleveland. Low-key. Not flashy. A bit boring, even.
Reminds us of the early days of Wal-Mart, when the company didn't raise an eyebrow among big-time analysts. Wall Street treated Sam Walton's Arkansas boys like a bunch of hillbillies, it seemed. But these sleepy, small, "boring" companies -- with no hype built into their stock prices -- can offer outstanding bargains to us individual investors.
Putting it together
Beating the market with small-cap stocks, as we've been doing in Hidden Gems, is not as difficult as you might think. We simply start by looking at what has worked in the past, and then we go looking for it again. If you'd like to check out all of our recommendations, plus the team's top five stocks for new money now, we're offering a 30-day free trial. Click here to give it a whirl.
This article was originally published on April 8, 2005. It has been updated.
Rex Moore is a Stock Advisor analyst and contributes the Foolish 8 screens to Hidden Gems. He does not own shares of any company mentioned. Google is a Motley Fool Rule Breakers recommendation. Wal-Mart is an Inside Value choice. The Motley Fool is investors writing for investors.