The Home Run Stock You're Too Afraid to Buy

Do you remember when you tried your first beer because everyone else was doing it? Are you the type who sees all the big movies on opening weekend so you can talk about them at work on Monday morning? Or maybe you bought Wells Fargo (NYSE: WFC  ) or US Bancorp (NYSE: USB  ) in late 2006 because housing was doing awesome and those companies were rolling in the money? Humans are social animals, but that impulse to be part of the crowd is destroying your chance to find the next home run stock.

"Don't look dumb"
Michael Lewis, the author of Liar's Poker, is one of the great raconteurs of business tales. While he's dismantled Wall Street in his firsthand account of life as a trader, he's also probed the cozy world of baseball in the more recent Moneyball. In this latter book, he explores why the Oakland A's -- one of the lowest-budget teams in all of baseball -- suddenly became one of the winningest around the turn of the 21st century.

The team didn't do what everyone else was doing. It defied conventional wisdom with a unique process:

  1. By working with experts, the team's otherwise-emotional general manager, Billy Beane, implemented a new, scientifically based means to evaluate talent.
  2. The general manager had to implement his system even though all of his talent scouts -- and most of the entire league -- thought the method was useless.
  3. After he’d snapped up his new talent at low prices because no one thought the players were good, Oakland suddenly began to dominate the league, even though it had one of the lowest payrolls in the country.

The secret?
Sure, the system was good. But the scientific basis had been around for a couple of decades. In fact, the developers of the system had to practically beg baseball teams to use it. Until Beane came along, baseball teams continued to do what they had always done, because it was safe. No one would criticize you if you bought what everyone else was buying. The real secret, Lewis confides, is that Beane had the courage to look dumb if his system didn't work. It's much easier to do what the crowd does and fail than it is to do something different and succeed.

And what held major league teams back for decades is what's holding many investors back from the next great stock. They're afraid to look dumb. That's it.

All greatness comes from the contrarian
Oakland's contrarian streak is what led it to success. That's exactly the approach that the experts at Motley Fool Hidden Gems use when evaluating a small-cap investment. And it's what Hidden Gems co-advisor Seth Jayson told CNBC when he discussed investments with the talking heads: He's not afraid to pick the great stocks that no one's heard of.

Superior investments are found where no one else is looking. That means that you and your friends have probably never heard of the big winner of the next decade. Who had really heard of Hansen Natural 10 years ago? It was a $53 million company then. Since that time, this purveyor of Monster energy drinks has become a $3 billion behemoth. That's 48% average compound growth. You simply can't find that kind of growth if you buy the "smart" stocks that everyone knows, the Procter & Gambles (NYSE: PG  ) and Boeings (NYSE: BA  ) of the world. They'll never grow that fast again.

Hansen Natural wasn't just some lucky story; it had great execution even back then. In 1999, the company sported attractive metrics such as a 28% return on equity and a 26% return on capital. But who had heard of it? The world was enthralled with dot-coms that subsequently went bust. 

If you didn't own one of the New Economy businesses, you were a fool, since they would grow forever. Even superinvestor Warren Buffett was laughed out of town for refusing to buy what the crowd was snapping up. But years after the dot-com bubble burst, Buffett is as wealthy as ever, while those who followed the fashion are bust.

Here are some lesser-known small caps that today have the same high returns on capital and equity that Hansen had before its big run:

Company

Market Cap

P/E Ratio

Return on Capital (TTM)

Return on Equity (TTM)

PRG-Schultz International (Nasdaq: PRGX  )

$138 million

7.8

37.9%

82.1%

RINO International (Nasdaq: RINO  )

$576 million

17.8

24.4%

50.5%

Blue Nile (Nasdaq: NILE  )

$909 million

85.9

31.5%

34.8%

All data from Capital IQ as of Oct. 5, 2009. TTM = trailing 12 months.

Small is beautiful
The expert analysts at Motley Fool Hidden Gems look exclusively for the market's overlooked small-cap stocks. That's where you're going to find the next great home run stock -- if you, like Billy Beane and Warren Buffett, are not afraid to go against the crowd.

If you'd like our experts to help you find superior small-cap ideas, you can check out all of our Hidden Gems stock research, as well as our eight "Buy First" small caps for new money now, free for the next 30 days.

Click here for more information.

Already a Hidden Gems subscriber? Log in here.

Fool contributor Jim Royal owns shares of Procter & Gamble. Hansen Natural and Blue Nile are Motley Fool Rule Breakers recommendations. Procter & Gamble is an Income Investor selection, and the Fool owns shares of it. The Fool has a disclosure policy.

 


Read/Post Comments (3) | Recommend This Article (15)

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 October 10, 2009, at 9:46 AM, ron153 wrote:

    If a baseball strategy doesn't work, you try something else. If an investment strategy fails, your money is gone, and you have no opportunity to try something else. The metaphor in this article is not only absurd, it is dangerous.

    I recommend a healthy dose of research into what successful investors like Warren Buffett, Prem Watsa, Carlos Slim, and George Soros are doing. These guys didn't become bilionaires by luck, and there is no shame in getting ideas from them. Investing isn't about boosting your ego and employing maverick ideas, it is about protecting capital and making money.

    Ron Beasley

    Investment Advisor

    www.rwbi.net

  • Report this Comment On October 10, 2009, at 3:29 PM, Superfoolball wrote:

    Not only might this metaphor be dangerous as applied to money, but Moneyball's attempt to glorify applying "science" to baseball to manufacture the Billy Beane "genius" myth has been substantially disproved by time. First of all, the A's have not won a single World Series since Beane took over as GM, even during the "Moneyball Glory Days". Second, time has shown that it was not Beane's genius or scientific strategy of high OBP, cheap players that brought success.

    Success came down to what it always comes down to: great starting pitching. Beane's "genius" coincided directly with the emergence of three young, stud pitchers (all of whom were homegrown, and hence organically cheap, talent - not the brilliantly inexpensive pickups that Moneyballers claim are the hallmarks of Beane's genius). As long as the A's Big 3 of the turn of the 21st century stayed in Oakland and pitched well, the A's won despite having a cheap, subpar lineup with the exception of a few pricey studs like Giambi. Once the Big 3 moved on, the A's settled back into obscurity. Where did the finely tuned, fully implemented Moneyball system get Beane and his A's this year? Last place in their division. Where are the genius accolades now? (Of course, the A's have a new class of studly young arms coming up, so maybe we're in for another "Golden Age" of Beane "genius" - christmas, what a charade).

    The A's had a small taste of what the Braves had for a much longer period of time: a core of stud starting pitchers. As with the Braves, the A's success lasted just as long as that core stuck around. Maybe someone should write "Coxyball" and label Bobby Cox a genius. IMHO he deserves that label a heck of a lot more than Billy Beane. At least he's won a title.

    In sum, this article is based on a false premise and therefore should be discounted.

  • Report this Comment On October 12, 2009, at 10:25 PM, ozzfan1317 wrote:

    Speaking of home runs Ebix is splitting their stock 3 for 1. Looks like they could be offering big returns soon.

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