Here's Your Shot to Score Big

Some of the best investment advice I’ve ever heard came from "The Great One."

But I don't mean Peter Lynch, Benjamin Graham, or even Warren Buffett (though as you’re about to see, Buffett is a big fan of The Great One, too). And I definitely don't mean Jim Cramer.

You've probably heard The Great One's name dozens of times, but you may not know just how wise he is. Nonetheless, he's said some very smart things. For instance ...

"You miss 100% of the shots you never take"
That's but one of the many pearls of wisdom The Great One has dropped over the years. And while it might seem obvious, or even trite, it's a truth we often take for granted.

Just think of the person you never asked to the dance, or the job you never applied for, or the novel you never finished ... or the stock you never purchased.

It happens to all of us. We get nervous, or doubtful, or busy, or ... you name it. And that might end up costing us the person of our dreams, or the job we've always wanted, or our only shot at fame. But in the case of investing, it will definitely cost us a fortune.

Back in 2007, two stocks sat on my watch list for a full 365 days:

Stock

Gain in 2007

Market Cap Today (in billions)

Apple (Nasdaq: AAPL  )

134%

$148

Chipotle (NYSE: CMG  )

158%

$2.9

A $24,600 mistake
Should I have bought them? Perhaps. But by not investing in them, I wound up making a grand total of ... nothing. Nada. Zip. Zilch.

However, had I decided to take a shot, I would have scored -- big time. Five grand invested in each company at the beginning of 2007 would have been worth more than $17,000 one year later.

Granted, both of these stocks were decimated in 2008 -- right along with virtually every other stock out there. Some of you will no doubt argue that these businesses were drastically overvalued in 2007, and that it's actually a blessing I didn't end up buying either of them.

But both are expertly managed, cash-generating businesses that I fully believe will build shareholder value over the long term. Had I bought them in 2007, I would have had a shot to lock in some incredible gains -- and despite an impressive run-up in both, investors like us now still have a shot to build positions on the cheap.

But if we want to score really, really big ...
We have to follow The Great One's most famous piece of advice: "Skate to where the puck is going, not to where it's been."

You may already know that The Great One is ice hockey legend Wayne Gretzky. If not, all you need to know is that Gretzky was arguably the greatest player ever to take the ice.

What made him The Great One? Quite simply, he was always one step ahead of everyone else -- not because of his speed, but because of his anticipation. While everyone else skated to where the puck had just been, Gretzky always skated to where it was going next.

That's the key to great investing, too
And I'm apparently not the only one who thinks so. In an op-ed piece he penned for The New York Times, Warren Buffett used this same quote to make the point that investors who keep their cash on the sidelines when market sentiment is negative are missing out on a potentially huge opportunity.

While I couldn't agree more with Mr. Buffett, I think this quote has an even more meaningful connection to small-cap investing. If you look back at my watch list, you'll notice an interesting correlation between market cap and percentage gain: The smaller the business, the greater the returns. That won't always be the case, of course, but it's a quick and dirty way of showing that the best performers do indeed start small.

That's how you can skate to where the puck is going next.

It's simple math, really. While Apple is one of the world's most powerful and innovative companies, it would have to pack on another $148 billion for its shares to double again.

Meanwhile, if Chipotle gains even one-tenth that amount, its share price should soar over 500%!

Bigger isn't better, but size does matter
Here are a few big gainers that began 2007 with market values greater than $5 billion, and how they ranked in price performance:

Stock

Gain in 2007

Rank Among Large Caps

Amazon.com (Nasdaq: AMZN  )

135%

No. 9

Research In Motion (Nasdaq: RIMM  )

166%

No. 4

Mosaic

342%

No. 3

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

And here are a few companies that began 2007 with market values less than $5 billion (but more than $50 million):

Stock

% Gain in 2007

Rank Among Small Caps

Baidu.com (Nasdaq: BIDU  )

246%

No. 33

SunPower

251%

No. 31

China Finance Online

392%

No. 5

Data provided by Capital IQ.

While the gains of the top-performing large caps were certainly impressive, it's worth noting that the 33rd best-performing small cap returned 80 percentage points more than the fourth best-performing large cap. In fact, of the top 10 overall performers, none was a large cap.

For further proof, just have a look at the top five best-performing stocks of the past 52 weeks with market caps greater than $5 billion:

Stock

Market Cap

52-Week % Gain

NetEase.com (Nasdaq: NTES  )

$5.8 billion

89%

Ford (NYSE: F  )

$26 billion

65%

Discovery Communications

$7.2 billion

57%

Aluminum Corp. of China

$16.6 billion

47%

Cerner Corporation

$5.2 billion

44%

Data provided by Google Finance.

Now compare that to the top five best-performing stocks of the past 52 weeks with market caps less than $5 billion:

Stock

Market Cap

52-Week % Gain

HeartWare International

$219 million

4,230%

Vanda Pharmaceuticals

$381 million

1,500%

Diedrich Coffee

$123 million

1,293%

Kirkland’s

$252 million

550%

OncoGenex Pharmaceuticals

$167 million

539%

Data provided by Google Finance.

Here's how can you score big in 2009:
First off, keep Buffett's advice in mind. Second, keep The Great One's advice in mind. Finally, take a page out of my colleague Tim Hanson's book, and make sure to look for stocks that are:

  1. Obscure
  2. Ignored
  3. Small

These three traits have characterized some of the best-performing stocks of the past decade. More importantly, they will characterize some of the most lucrative stocks of the next 10 years.

In fact, we started our Motley Fool Hidden Gems service precisely to uncover businesses with these three traits -- companies poised to rank among the very best investments of the next decade and beyond.

In other words, the Hidden Gems team is dedicated to discovering where the puck is going next. And thanks to the recent market sell-off, many of today's most promising small-cap stocks are still selling at bargain-basement discounts. Basically, if ever there were a perfect time to take your shot and score big, this is it.

If you'd like to learn more, or you just need a little help uncovering great small-cap businesses, you can see all of our recommendations -- including our top two picks for new money -- with a free 30-day guest pass. You'll also be able to follow along as the Hidden Gems team invests $250,000 of The Motley Fool's own money in a best-of-the-best small-cap portfolio.

This offer is completely risk-free, with no obligation to subscribe. To get started, simply click here.

This article was first published Jan. 25, 2008. It has been updated.

Austin Edwards finally did buy shares of Apple, Chipotle, and Google in 2008. Apple and Amazon.com are Motley Fool Stock Advisor recommendations. Chipotle, Baidu.com, and NetEase.com are Rule Breakers picks. Chipotle is also a Hidden Gems recommendation and a Fool holding. The Fool's disclosure policy is the coolest game on Earth.


Read/Post Comments (2) | Recommend This Article (9)

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 10:57 PM, smalltalker3000 wrote:

    I can't believe you would even name stocks like Heartware as examples of where a lot of money could have been made. The stock volume is still less than 20k per day. If you would, in all honesty, had ever actually recommended that stock (and not just imply it that you might have), I would walk away from your service as fast as I could. Buying Heartware would have even given me worse odds than playing poker at a Casino.

  • Report this Comment On August 13, 2009, at 3:57 AM, jjun0366 wrote:

    Vanda (VNDA)????? after failing to get FDA approval it dropped like a rock and then it shot up 1000% in a day because of an unexpected fda approval.

    The picks are very misleading. Unless you stated that VNDA was a net net and was trading considerably less than its liquidation value, the rationale would have stuck but I could just as easily pick some high flying small cap and say that small is the way to go.

    I'm a deep value micro small cap investor myself and am up over 1000% on VVTV but I have research to back it up.

    Seems like very article on Fool is more of a sales pitch than intelligent investing.

    Would seriously like to know whether Heartwave, Vanda, Deidrich etc were on the strong buy list for the hidden gems newsletter.

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