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Big Winners for Small Investors

There's an old, illuminating story in investing circles, and it goes something like this ...

A cocky Midwest billionaire once boasted he could earn 50% profits year after year, investing in nothing other than ordinary common stocks. Of course, there's a condition.

Or maybe that's all it is -- a story. After all, that's a pretty tall order, and it's been debated for years. So, you're right to wonder: Did this guy really make that claim? And if he did, what was his one condition?

Enter a flock of Jayhawks
While we bickered over who said what and when, a courageous class of business students did something about it. They traveled from their campus in Lawrence, Kan., to Omaha, Neb., and set up a meeting.

Then they asked the guy: Did he ever really make that "50% per year" guarantee? And more important, would he stand by it? He didn't just confirm it -- he went further.

You'll be surprised how he would do it
To earn that 50% per year -- essentially doubling your money every 20.5 months -- this fellow wouldn't buy the blue-chip giants that made him one of the world's richest men ... or even his own $160 billion company.

He'd buy companies with names you've probably never heard. How do I know? He told us. Remember that one condition?

Well, this guy would promise to earn us 50% per year ... only if we had less than $1 million to invest. That's because he would be loading up on undiscovered, thinly traded small companies -- the one spot in the market where individual investors like us have an advantage over the pros.

Why Warren Buffett wishes he were you
You guessed it was Buffett, didn't you? Well, can you guess why he wishes he were you? Because he has too much money. I know, that sounds crazy. After all, the big money has all the advantages, right? Wrong.

For one thing, big boys like Buffett have way more than $1 million to invest, so they can't mess with small companies, no matter how great their potential -- at least not without risking running up the price or buying a controlling stake in the firm.

That's one reason why you see so much trading volume in the usual suspects. Take a look at these names among the most widely owned and heavily traded NYSE stocks.


Market Capitalization

Average Volume

Merck (NYSE: MRK  )

$65 billion

19 million

Citigroup (NYSE: C  )

$20 billion

400 million

ExxonMobil (NYSE: XOM  )

$332 billion

25 million

Sprint (NYSE: S  )

$10 billion

41 million

Alcoa (NYSE: AA  )

$12 billion

38 million

And over on the Nasdaq? How about Comcast (Nasdaq: CMCSA  ) and News Corp. (Nasdaq: NWS  ) , each trading multiple millions a day. On Wall Street, they call this liquidity -- a polite way of saying "the usual suspects buying and selling the same old stocks to each other."

So, if you've got half a billion to put to work this afternoon, you'd better buy something big and forget about the next big thing. But don't expect to be dazzled; even after getting beaten up in 2008, those usual suspects don't have many doubles left in the tank -- much less one every 20 months or so.

Wait a minute! Aren't small companies risky?
Yes and no. Ibbotson Associates tracks stock returns by "style" and market cap. You could have invested $1,000 in Ibbotson's large-cap universe back in 1927. Over the course of 80 or so years, it would have grown to about $2 million. Not bad.

If you'd bought small-cap value stocks instead, you'd have more like $30 million. Of course, the word "value" here is key. In fact, combining the potential of small caps with old-school value is the missing link between big profit potential and Warren Buffett's grind-it-out success.

My old friend and Motley Fool co-founder Tom Gardner hammered this into my head when I worked with him on his Motley Fool Hidden Gems newsletter service. I know firsthand how dramatic the returns can be when you focus on unloved, obscure, and (most important) underpriced small companies.

"Be greedy when others are fearful"
That's something else I learned from Buffett. So if you're more comfortable waiting for a pullback after the recent rally, I can respect that. But don't wait too long. I still think this market is a buying opportunity for opportunistic investors. But you're right to pick your spots.

Here's a solution. Sample Motley Fool Hidden Gems for free right now. You can check out the two top picks the analyst team thinks are best positioned to make you money. While you're at it, jot down the stocks they are buying for their real-money portfolio – so you'll have them when you're ready to buy.

But again, I wouldn't sit too long and get caught on the sidelines. I have a hunch the guys at Hidden Gems can help make you money. I guarantee they'll make you a better investor. If you have less than $1 million to invest, that is.

Best of all, there's no risk for you. If you're not absolutely convinced at any point during the first 30 days, I'll make sure you don't pay a dime. This way you'll be ready to move when you decide the time is right. Even Buffett would be proud. To learn more about this free trial offer, click here.

Already subscribe to Hidden Gems? Log in at the top of this page.

This article was originally published on Feb. 10, 2006. It has been updated.

Paul Elliott doesn't own any stocks mentioned. Sprint is a Motley Fool Inside Value recommendation. You can view the entire Hidden Gems scorecard and real-money portfolio with your free trial. The Fool has a disclosure policy.

Read/Post Comments (2) | Recommend This Article (6)

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 August 12, 2009, at 12:28 PM, delusioned wrote:

    Yet another tired sales pitch for a Fool service, dropping the Buffett name and quotes ad nauseam. I wonder if you guys pay any royalty to Warren, each time you write his name on a line - not that he needs it, but would put the money to much better use. A lifetime ago, the Fool used to be different - why do all good things come to an end...

  • Report this Comment On August 12, 2009, at 3:10 PM, davidjon13 wrote:

    delusioned, first of all, Motley Fool became greedy when others were greedy. Second of all, they were never really much better at maximizing the user's investments - although their articles were not all advertising, and were a lot more pleasant to read.

    delusioned, do you remember a few years ago, when they were saying that most investors should be 100% invested in stocks, and should either buy an index fund such as Vanguard's S&P500 fund, or invest in the "dogs of the dow"? What would have happened to someone stupid enough to do that about 11 years ago, when they were saying it? What would their total return be today? (Hint: A significant loss for the index fund, even ignoring inflation and taxes, and a large loss for the dotd.)

    Another question: Many of the Motley Fool's writers have less than a million dollars to invest (though they may have well over that sum in net worth). How many of them are getting a 50% annual return doing what the Motley Fool says that we should be doing what Mr. Elliot suggests?

    How does one spell "dishonest"?

    I don't know if they still do this, but it used to be that their free offers were all automatically renewing, and you had to contact them by phone or email to discontinue your subscription. Before you buy ANYTHING from them, try to use email or a phone to contact a human being there. I did try.

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