These Are the Market's 10 Best Stocks

The best stocks? Is that really what I'm going to write about, after a year in which the S&P 500 dropped by nearly 40%?

It is, actually. You learn pretty rapidly in this business that the best way to make money in the market is to invest for the long term, and you recognize that volatility is part of the ride. And when you commit to the long term, you quickly discover that the stocks that offer the best returns today aren't well-known, widely owned names.

But I'm getting ahead of myself. Before I can get to the takeaway, I have to show you the data. This is a simple list of the top-performing stocks of the past 10 years. I compile this list at the end of every year, and every year, it yields the same fascinating insight:

Data from Capital IQ, a division of Standard & Poor's. Includes only U.S.-listed stocks with verifiable stock price histories on major exchanges.

The trait that sets these stocks apart
What does an energy-drink maker (Hansen) have in common with a biotechnology leader (Celgene)? A home-nursing practitioner (Almost Family) with the makers of Ugg boots (Deckers)? A natural-gas driller (XTO) with some guys who sell java (Green Mountain)?

On the face of it, not much. But if you look closely, you'll see that these were all very small companies when their amazing stock market runs began.

To see just how important it is to start small in the market, take a look at the returns that the 10 best large caps offered over the same period of time:

Data from Capital IQ and is adjusted for dividends.

Or the somewhat more dynamic mid-caps:

The returns just don't stack up to the small guys.

Here's what's special about very small companies
And although companies such as Celgene and XTO are big-cap market darlings today, tracked and owned by big institutions such as Goldman Sachs and TIAA-CREF, and the New York State Common Retirement System, the next Celgene and the next XTO are being ignored and undervalued -- just as Celgene and XTO were 10 years ago! That's because companies like these are too small and too obscure to be worth Wall Street's "valuable" time.

So if you want to buy the best returns, you have to look at stocks today that are:

1. Ignored.
2. Obscure.

And, most of all:

3. Small.

That was the case at the end of 2005, 2006, and 2007 as well.

They're out there
At Motley Fool Hidden Gems, these are precisely the types of companies we spend our time looking for. Rather than tracking $24 billion Celgene, we follow Natus Medical, a $400 million maker of health screening products for newborns, in the health-care space.

Though Natus is small, we believe it's well managed, cash-conscious, and poised to take advantage of enormous market opportunities. That last point, after all, spurs the best small companies to grow big, and that's what we believe our Hidden Gems recommendations can do for your portfolio.

Your Mid Year's resolution
So take this lesson from the market's 10 best stocks, and put it to work in your portfolio this coming year by buying small caps. If you'd like some help doing just that, you can see all of our Hidden Gems research and recommendations by joining the service free for 30 days.

Click here for more information.

This article was first published Dec. 24, 2008. It has been updated.

Tim Hanson does not own shares of any company mentioned. Natus is a Motley Fool Hidden Gems recommendation. Quality Systems and Apple are Stock Advisor picks. Southern, Posco, and Bank of Nova Scotia are Income Investor choices. Hansen Natural and Green Mountain Coffee Roasters are Rule Breakers selections. This is the Fool's best disclosure policy.