Buy This Stock Before Your Neighbor Does

The overwhelming majority of people are comfortable with consensus, but successful investors tend to have a contrarian bent. -- Seth Klarman, founder of the Baupost Investing Group

I learned early on that I come from contrarian stock. At 10 years old, I asked my dad why he didn’t buy a nice new car like the other dads in the neighborhood -- after all, he worked hard days and weekends and could have afforded it. He looked at me and said, "Son, cars are depreciating assets."

Despite examples to the contrary, however, we as humans are hardwired not only to care what other people think but to follow the herd in almost every scenario.

Especially your neighbors
Consider the following experiment conducted by Robert Cialdini, professor of both psychology and marketing.

He wanted to find out what would persuade people to conserve energy, so he put leaflets in people's doorways with different messages. One control group received no leaflets; one group received leaflets with facts about how energy conservation helps the environment; another group received information on how much money they could save; and one group received leaflets that said, “The majority of your neighbors are conserving energy.” Later, they checked the gas meters to see who had, in fact, changed their energy consumption.

I’m sure you see where I’m going with this -- the most effective leaflet was the one telling people that their neighbors were conserving energy. As Cialdini says, people will almost always do things they know or believe other people are doing. Think about how many times you’ve stopped and looked up at the sky just because other people were doing it.

That's why bubbles are so devastating -- we tend to get caught up in the excitement, buying shares of Yahoo! (Nasdaq: YHOO  ) and Amazon.com (Nasdaq: AMZN  ) for more than $100 per share right before they plunged below $10 a pop. We couldn’t help it -- everyone else was doing it.

Far from the madding crowd
There are some great reasons to practice going against the grain -- especially when it comes to investing.

Following stocks that everyone else is following hardly gives you much of an advantage -- you’re forced to compete against not only thousands of other investors, but hundreds of scrupulous Wall Street analysts.

On the other hand, tracking stocks that are typically ignored -- i.e., small-cap stocks -- allows you to find mispricing situations, and once you can identify a great company that’s undervalued -- well, you’ve just hit a gold mine.

For example, I bet most of your neighbors haven’t heard of Dynamic Materials (Nasdaq: BOOM  ) . This $250 million company specializes in explosive metalworking and caught the eye (and the recommendation) of our Motley Fool Hidden Gems analysts.

A decade ago it was a penny stock, but today it’s experienced almost 40% annualized growth. It's had revenue growth of more than 30% a year for the past five years, great competitive advantage, and consistent returns on equity.

You simply can’t find that type of growth from companies your neighbors have already heard of -- blue-chip stocks like Pfizer (NYSE: PFE  ) or Wal-Mart (NYSE: WMT  ) . Those companies are just too big to grow that fast again.

Keep it in the family
To find the stock champion of the next 10 years, you’ll need to avoid the herd -- and look where your neighbors aren't. That means seeking out small-cap stocks that are being ignored, then finding the ones that have excellent growth, return money to shareholders, and are trading cheaply.

For example, here are some lesser-known small caps that have the same qualities Dynamic Materials had before it saw those enormous gains:

 

Market Cap

P/E Ratio

5-Year Annualized Revenue Growth (TTM)

Return on Equity (TTM)

Pinnacle Airlines (Nasdaq: PNCL  )

$126 million

3.9

10%

47.6%

Innophos Holdings (Nasdaq: IPHS  )

$445 million

2.5

18%**

94.9%

Vascular Solutions

$143 million

7.7

32.6%

76.6%

*Data taken from Capital IQ as of Oct. 16, 2009, and from Yahoo! Finance. TTM=trailing 12 months. **Only 3-year growth was available.

I’ll be honest -- not all small-cap stocks are going to be a perfect fit. But if you have the guts to pick the less popular stocks, your portfolio will surely reap some tremendous benefits.

Those are the kinds of stocks we buy for our Hidden Gems real-money portfolio-- and our picks are beating the market. If you’re interested in seeing the stocks our analysts are recommending, just click here for a free, 30-day trial. There's no obligation to subscribe.

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

Fool contributor Jordan DiPietro owns no shares of the stocks above, but will always be grateful for his father’s wise advice. Dynamic Materials and Innophos Holdings are Motley Fool Hidden Gems recommendations. Amazon.com is a Stock Advisor selection. Pfizer and Wal-Mart are both Inside Value picks. The Fools disclosure policy doesn’t worry about keeping up with the Joneses.


Read/Post Comments (25) | Recommend This Article (134)

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 16, 2009, at 2:09 PM, pondee619 wrote:

    Jordan:

    What has been the stock performance, relative to the S&P, of BOOM since it was recommended by HG? I haven't seen the relative performance of Fool publications published for quite some time. A thirty day "free" trial, with the submission of your credit card info, is nice, but, a report of the publications' records would go a lot further in securing readers, no? Is only "Stock Advisor" doing well?

  • Report this Comment On October 16, 2009, at 3:59 PM, TMFPhillyDot wrote:

    @pondee619

    Thanks for the comments. The performance of BOOM since it's been recommended has been an 124% gain, and an 85.6% gain against the S&P. There are also many other publications that are doing well -- off the top of my head I know that Income Investor, Global Gains, and Million Dollar Portfolio are all beating the S&P.

    And with regard to the free trial -- you get full access just like you were a member. So you see all their past and present recommendations, return vs. S&P, etc. It's a great opportunity to see what the comprehensive product is like without having to pay for it.

    Fool on!

    -Jordan(TMFPhillyDot)

  • Report this Comment On October 16, 2009, at 4:19 PM, pondee619 wrote:

    06/26/2008 Dynamic Materials BOOM -40.22% -16.26%

    -23.96% Tom Gardner & Seth Jayson

    Translation off the HG Classic Score Card

    Recommended June 26, 2008, BOOM -40.22% S&P -16.26% Return relative to S&P -23.96, Recommended by Tom & Seth.

    Now explain where your numbers came from. By the way, cancell my free subscription. I just got it to confirm your numbers.

  • Report this Comment On October 16, 2009, at 4:32 PM, TMFPhillyDot wrote:

    @pondee619

    I apologize for the confusion. You were referencing the classic scorecard and I was looking at the actual money portfolio. Our open position on BOOM is up 85% against the S&P. It is labeled as a "BUY" under the portfolio tab. However, you are absolutely right about it being down on the classic scorecard. Just a misunderstanding, that's all.

    We are all about transparency at the Fool.

    Best,

    Jordan(TMFPhillyDot)

  • Report this Comment On October 16, 2009, at 5:22 PM, don1104 wrote:

    Ref: BOOM...an exective shareholder sold the majority of his stock...something to think about

  • Report this Comment On October 16, 2009, at 5:29 PM, pondee619 wrote:

    I was referencing your score from the time HG recommended the issue. It must be great to wipe out a period of underperformance and claim "Victory" how do I do this in my real portfolio? From the time HG recommended BOOM it is DOWN to the S&P. Stop claiming otherwise. you can't wipe out years of losses just by saying so.

  • Report this Comment On October 16, 2009, at 5:36 PM, mikecart1 wrote:

    Boom boom boom let me hear you say wayo!!!! (WAYO!!)

  • Report this Comment On October 16, 2009, at 8:40 PM, thisislabor wrote:

    I hate to eyeball the financial statements right quick like, but I did.

    And as far as I can tell the company may be a small cap stock but its got good revenue, and cash flow from operations which is like the most important thing. It did take out a large amount of debt 2 years ago, but it seems to be paying it off with every dollar it has last year.

    From what I can tell by eyeballing the financial statements for all of 30 seconds total, it seems to be a semi well run company, but in a small retraction of income.

    When the economy comes back to life my money is that it would take off.

    Anyone else guess the same or I am delusional and need more education//experience?

  • Report this Comment On October 16, 2009, at 8:41 PM, thisislabor wrote:

    I'm referencing BOOM, btw.

  • Report this Comment On October 16, 2009, at 8:44 PM, thedofca100 wrote:

    >>"Son, cars are depreciating assets."<<

    Yes, they are and they are also expensive to maintain. We buy new cars every three years and we never have to pay to repair anything. The are ,essentially, never broken down when we need them. I wouldn't put the money into maintaining an old car ever. Over the many years we've had cars we have enjoyed new cars at less cost than maintaining an old one. Does that make us the contrary ones?

    Also, I purchsed the report from Motley Fool that told you which stocks to hold onto for 10 years to make lots of money. It's not ten years yet but things aren't looking too good. Most of them are still down substantially. But who knows?

  • Report this Comment On October 16, 2009, at 8:53 PM, thisislabor wrote:

    Yeah, a small retraction of income.

    Wonder when it will post completely. about 5 years to depreciate out at that rate?

    Some how I read that as 24, and not a 34 in the cashflow statements. missed that completely.

    I must be tired.

    But yeah, I had the right thinking on the investing activites. explains why income doubled the following year.

    yeah that stock will triple in price shortly.

  • Report this Comment On October 16, 2009, at 9:07 PM, nogrthinker wrote:

    Well, let's see I bought BOOM on Sept9, 2008. It's now down 31.56% from where I bought it. Other recommendations of yours that I've followed have done better.

  • Report this Comment On October 17, 2009, at 9:04 PM, 8Lives wrote:

    I love the Fool -- but why can't someone grow a pair and make some actual "penny stock" suggestions -- not tell us how rich we could be IF we had invested in "chubak-chu-betchya" when it were a nickel. I know your intent is to groom us and get us thinking like wily inestors, but come on ... throw us a frickin' bone here...

  • Report this Comment On October 18, 2009, at 1:40 AM, VerySharp wrote:

    ok, since you have asked,

    BIEL @ .08

    is one such penny stock. Ready to go up to great heights...

  • Report this Comment On October 18, 2009, at 2:53 PM, thisislabor wrote:

    god, I love this board.

  • Report this Comment On October 18, 2009, at 2:59 PM, thisislabor wrote:

    thedofca100,

    can I ask do you guys take into account your after tax costs to go through new vehicles all the time?

    how much money do you spend on the vehicles?

    why are you bringing back in the vehicles every 3 years instead of like every 7 years - 10 years? most major repairs on vehicles dont start until around 70-100k miles?

  • Report this Comment On October 19, 2009, at 4:01 PM, canticle wrote:

    Thank goodness for folks like thedofca100, otherwise I would never have a car to drive. I let them eat the depreciation and sales taxes on full price. After purchase, I keep them for another ten years or so before I sell them off in trade for the next three year old car. Maintenance?? Treat them nice, change the oil and tires. Of course it helps to purchase a well made car to begin with. Just like a good stock.

  • Report this Comment On October 19, 2009, at 4:22 PM, foolishlew wrote:

    thedofca100,

    My neighbor is a 'new car every 3 years' kinda guy.

    To him appearance is most important and he will claim economy over sensibility even though he can't support it. He never maintains the cars - doesn't even change the oil. Drives them 40 to 60 thousand miles and only keeps them clean, leaving any neglect for the next owner to handle. On the other hand, I always have 3 vehicles (2 cars and one pickup) that I replace on a rotating schedule - one every 7 to 10 years. Yes, with proper maintenance they all last from 20 to 25 years or longer and run for 250,000 or more miles without major repairs. In 45 years I have had one major repair of an air conditioner at $1100. All other costs are proper maintenance. I'm sure I spend less on my 3 vehicles than my neighbor spends on his one 'always new' vehicle. Just his sales tax, interest, license costs, and insurance on his new cars is more than my total cost for one of my cars.

  • Report this Comment On October 19, 2009, at 5:26 PM, markosaur wrote:

    Analysis has shown that retaining, maintaining & repairing an old car is almost always cheaper than buying new.

  • Report this Comment On October 19, 2009, at 5:35 PM, louiswilliams wrote:

    I am still trying to figure out from the above article which stock I am supposed to buy before my neighbor does....what is obvious is that this is advertisement for a HG's membership.

  • Report this Comment On October 19, 2009, at 5:40 PM, colddrink73 wrote:

    On October 18, 2009, at 1:40 AM, VerySharp wrote: ok, since you have asked,

    BIEL @ .08

    is one such penny stock. Ready to go up to great heights...

    Ummmm.... hey guys I'm not saying that this stock won't take off like "VerySharp" says it will but I don't know how much I would trust someone who has no picks on their CAPS. I'm just saying..

    If it walks like a duck and quacks like a duck.

  • Report this Comment On October 20, 2009, at 10:40 AM, rukiinvstr wrote:

    The bulk of communication from the Fools offices are 30 day free trials to sell more subscriptions to one of their many "get rich" advisory services. There is no way to accurately judge a service in one month. That's why you (we) are dubbed "Fools" of the club bearing the same name.

    Bottom line - you have to do your own homework and research to find your way. Do the 10, 20, and more baggers happen? Yes, of course. But, NO ONE can advise on a Hidden Gem that is guaranteed to give you that "windfall" that we all hope to get lucky on.

  • Report this Comment On October 23, 2009, at 1:46 AM, Br0oklyn wrote:

    Very well written.Investments is all of what you make of them..

  • Report this Comment On October 23, 2009, at 1:32 PM, kmacattack wrote:

    Re: Buying new cars every 3 years, I've gotta agree with this is labor. I buy 2 or 3 year old vehicles,often insurance rebuilds at a fraction of new cost. Example, 6 years ago, I purchased a 2002 Chevy Pickup Dec. 31st as a business vehicle and wrote off the entire cost for tax year 2003 taking advantage of Bush's accellerated depriciation tax bill, which I still think was a bad idea because it put millions of new gas guzzlers on the road when we were, as in the prior 30 years, facing an "energy crisis". The truck had 7,800 miles on it, stickered for $27,000 new and I bought it for $12,000 rebuilt. I'm still driving it and the biggest expense after 150,000 miles has been a fuel pump other than tires and brakes.

    My step dad told me when I bought my first car

    'Son, the cheapest car you will ever own is the one you are driving right now"

    From 1978 till about 83, I bought one or two new Honda's per year, but there was a shortage of Hondas then and in some cases they actually gained value year to year, but when a substantial supply of Hondas hit the used market, it became much more expensive to buy new ones and trade often, so I stopped. I bought a rebuilt 03 Ford Taurus in 06 for $3,500 and the transmission just failed at 98,000 miles, but again, this has been a great car for 40,000 miles, and I can rebuild the tranny better than the original for $1,500 and keep driving it.. There is now way you can buy a new car and justify the expense as being as cheap as buying a used one, or repairing the one you are driving. That car just doesn't exist.

    If you can afford to buy the new car every 2 or 3 years and desire the status, pretige, etc. then that evidently equates to monetary value to you. It doesn't make sense to me.

    You can "invest" in new cars. I'll continue to invest in stocks and real estate.

  • Report this Comment On October 23, 2009, at 11:51 PM, farmerfloyd wrote:

    Most people waste there whole lifes income on new

    cars and trucks. Die with no net worth. I buy wrecked Acuras and Toyota trucks drive them 3-4 years and usually sell them for more then my cost.

    I am driving a 2003 Honda S-2000 sports car.

    Bought it stripped, bought 2 cars more for seats, front bumper, headlights, taillights, dash cluster. Only had to paint front bumper. after selling extra engines, 6 speeds, posi rear ends, I got car for free, took 2 months free time A new one costs 35K.

    Toyota best selling truck in WORLD. always drive for free, PreRunner most wanted. cant do it with a

    Dodge. haha

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