The Best Stocks for the Next 4 Years

Did I miss something, or have we completely emerged from the market's bottom?

We can't be sure just yet, but investors in Insmed (Nasdaq: INSM  ) , Satyam Computer Services (NYSE: SAY  ) , Allied Irish Banks (NYSE: AIB  ) , and RF Micro Devices (Nasdaq: RFMD  ) are likely convinced -- each of those stocks is up more than 50% over the past month!

But some analysts, like Nouriel Roubini, believe this rally will be short-lived and that stocks still have further to drop.

It's safe to say there’s negativity that still abounds
The late Sir John Templeton called scenarios like we've been in "points of maximum pessimism." He also taught that times of maximum pessimism are the best time to buy -- and he practiced what he preached.

When the Second World War began and stocks started to fall, he borrowed $10,000 and invested it in 104 companies whose shares were trading for less than $1 -- including 34 that were in bankruptcy. Four years later, he sold his positions for $40,000, booking a 300% gain on stocks the market thought were doomed.

With his example in mind, I believe the pessimism still lurking around continues to signal a buying opportunity.

Stocks to profit from pessimism
We should be buying stocks that, like Templeton's initial bet on pessimism, could become double- or triple-baggers in the four or so years coming out of this bear market.

We know the top stocks since the last recession began were mostly small caps -- albeit with a few mid-cap rock stars like Apple mixed in. Among other things, small companies can more quickly and efficiently cut costs and streamline operations than can larger companies with employees and resources scattered throughout the country and the world.

But what kinds of companies have outperformed since the end of that bear market? I ran a screen to see what kinds of companies were double-, triple-, or even-better-baggers as the recession receded. And sure enough, the best-performing companies over the following four years were all small caps:

Company

4-Year Return
from Oct. 9, 2002

Oct. 9, 2002 Market Capitalization
(in millions)

AmericaTower

5,137%

$139

YFP

2,857%

$434

Research In Motion

2,422%

$705

Bancolombia

2,067%

$203

WESCO International

2,054%

$142

Corning

1,890%

$1,173

Crown Castle International

1,830%

$373

AES

1,767%

$597

Coldwater Creek

1,670%

$131

McDermott International

1,616%

$232

Data from Capital IQ, a division of Standard & Poor's.

This list merely shows the top 10, but it's also true that small caps as a whole outperformed their larger brethren coming out of the last bear market -- and this phenomenon wasn't unique to that situation. According to T. Rowe Price research, small-cap stocks led the market out of the past 10 recessions, posting an average 28% gain, versus the 19% gain for large caps in the year following the market's recovery.

Given this data, I also ran a screen to see which small caps are dirt cheap right now -- and possibly poised to outperform as the market recovers. I looked for companies down more than 50% over the past year, and trading with price-to-earnings ratios below both that of the S&P 500 and their five-year average -- qualities I believe could make for Templeton-sized gains over the next four years.

Here are three companies from that screen. These aren't formal recommendations, but they're a good place to begin some further research.

Company

Market Capitalization

P/E Ratio

Patterson-UTI Energy (Nasdaq: PTEN  )

$1.9 billion

6.7

Macerich (NYSE: MAC  )

$1.4 billion

12.1

American Oriental Bioengineering (NYSE: AOB  )

$390 million

8.5

Data from Morningstar and Capital IQ, a division of Standard & Poor's.

All in the family
So if, like me, you're looking for the best stocks to carry your portfolio out of this bear market and into wealthy pastures in four years' time, you need to look for small, underfollowed companies like those above -- and like those we search for as additions to our Motley Fool Hidden Gems portfolio.

Hidden Gems is outperforming the market substantially since inception -- and now, advisors Andy Cross and Seth Jayson are building a real-money portfolio of their best small-cap ideas. If you'd like more insight into our favorite small-cap stocks right now, try out the service with a 30-day free trial. Click here to get started -- there's no obligation to subscribe.

This article was originally published Sept. 5, 2008. It has been updated.

Adam J. Wiederman owns shares of Allied Irish Banks, which is a Global Gains recommendation. The Motley Fool owns shares of Allied Irish Banks and American Oriental Bioengineering, which is both a Global Gains and Hidden Gems recommendation. The Motley Fool's bold disclosure policy is here.


Read/Post Comments (4) | Recommend This Article (43)

Comments from our Foolish Readers

Help us keep this a respectfully Foolish area! This is a place for our readers to discuss, debate, and learn more about the Foolish investing topic you read about above. Help us keep it clean and safe. If you believe a comment is abusive or otherwise violates our Fool's Rules, please report it via the Report this Comment Report this Comment icon found on every comment.

  • Report this Comment On June 20, 2009, at 7:07 PM, KalerSimth wrote:

    SAY is a winner, period. I've bought thousands of shares since the beginning of this year.

    I'm going to keep buying as well!!

    Good luck to all.

    http://top5stocks.blogspot.com

  • Report this Comment On June 21, 2009, at 6:47 AM, slavalava wrote:

    Personally, i"m looking for Bombej rally that aren't started allready. And when its started, everybody wil be wanted to get on this train ! The miising puzlle is when ?!? I bougth saytam in 3.5 $ last week, and hope to make this week as minimum 10%

  • Report this Comment On June 23, 2009, at 2:04 PM, PandJonB wrote:

    The Fool has been on this hook with recommending AOB ever since it was up in the double digits and look where it is now. I think that the Fool has to reconsider certain aspects of market psychology before recommending such companies as AOB. They haven't paid a single dividend to their shareholders since they've been in business. My advice to the Fool about this one is, "Stop being so Foolish about recommending stocks that only fools would invest in, in today's current market." Certainly today's current mantra is, "Show me the money!"

  • Report this Comment On July 10, 2009, at 8:12 PM, wrongdog wrote:

    Satyam Computer Services? This has to be the worst stock David Gardner ever recommended. Why would a Fool ever buy this again?

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