Stop me if you've heard this one. But the one stock you must buy is ... the next Apple (Nasdaq: AAPL ) , Amazon.com (Nasdaq: AMZN ) , eBay (Nasdaq: EBAY ) , and Baidu.com (Nasdaq: BIDU ) , all rolled into one.
That's a pitch I'm sure you've heard some semblance of at cocktail parties, golf outings, weddings, and, of course, on the Internet.
And it's a pretty appealing pitch. After all, Apple, Amazon, eBay, and Baidu are some of the stock market's great success stories. These companies have earned early investors mind-boggling returns over short and long periods of time.
The secrets of success
So the question is: Does that one stock you must buy exist? Of course it does. But can you find it? That's a different matter.
Here, however, is a litmus test to gauge every stock tip you come across. Simply ask: Does this company bear any resemblance at all to Apple, Amazon, eBay, or Baidu before they were big names?
That's not to say that one stock will be a tech superstar. Instead, Apple, Amazon, eBay, and Baidu all share a set of remarkable traits that characterized them when their amazing runs began. All were:
- Small
- Led by a dedicated founder (or founders)
- Fiscally conservative
- Profiting from a wide market opportunity
If the next stock pitched to you lacks these traits, you're probably better off passing.
A case study
Consider, for example, the cases of Advanced Micro Devices (NYSE: AMD ) and Altera (Nasdaq: ALTR ) -- two tech plays touted to me at cocktail parties, golf outings, weddings, and, of course, on the Internet.
Are they small? No. Both are $6 billion companies.
Are they led by dedicated founders? No. Both Derrick Meyer and John Daane came from other companies. Neither owns a significant percentage of his company's shares.
Are they fiscally conservative? Yes and no. While Altera has a strong balance sheet and a business that generates healthy cash flow, AMD -- due to the capital intensive nature of its business and competition with Intel (Nasdaq: INTC ) -- swung to an operating loss in 2007 and 2008, and the company continues to spend significantly on capital expenditures.
Do they have wide market opportunities? It gets a little cloudy here. While both companies have opportunities to grab greater market share, they both operate in extremely competitive industries. Whatever gains they make will be hard-fought and may not last.
The Foolish final word
I'm not here to be negative about either AMD or Altera. Both could make for good investments going forward. I don't, however, think either one has the core traits that made companies like Apple, Amazon, eBay, and Baidu such incredible investments and that we look for at our Motley Fool Hidden Gems small-cap investing service.
Again, we believe that tomorrow's big winners will start off:
- Small
- Led by a dedicated founder(s)
- Fiscally conservative
- Profiting from a wide market opportunity
If you'd like to take a look at the companies we've found that meet the four criteria mentioned, click here to join Hidden Gems free for 30 days.
Already subscribe to Hidden Gems? Log in at the top of this page.
This article was originally published Oct. 19, 2006. It has been updated.
Tim Hanson does not own shares of any company mentioned. Intel is a Motley Fool Inside Value recommendation. Baidu is a Rule Breakers pick. Apple, Amazon.com, and eBay are Stock Advisor selections. Motley Fool Options has recommended buying calls on Intel and bull call spreads on eBay. The Fool's disclosure policy assures you that no stocks were harmed in the penning of this article.
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