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 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 read, "The majority of your neighbors are conserving energy." One control group received no leaflets. 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 Schlumberger (NYSE: SLB) and Chesapeake Energy (NYSE: CHK) when they traded close to record highs, right before they plunged by more than 60%. 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, many of your neighbors probably haven't considered investing in Under Armour (NYSE: UA). Besides producing sweat-wicking T-shirts for athletes, this small-cap company has become a true player in the sport and apparel space. Once only a company that provided gear for professionals, Under Armour has quickly gained the loyalty of novices and exercisers all over the world. 

This loyalty has been reflected in sales -- revenues have increased by just about 30% in the last three years. The company's total debt-to-equity ratio is a paltry 5%, which might help explain how they are able to generate such significant cash flow. Because of its straightforward business and its double digit return-on-equity, Under Armour caught the eye (and the recommendation) of our Motley Fool Hidden Gems analysts.

You simply can't find that type of growth from companies your neighbors have already heard of -- blue-chip stocks like Microsoft (Nasdaq: MSFT) or Caterpillar (NYSE: CAT). 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, and then finding the ones that have excellent growth, that return money to shareholders, and that are trading cheaply.

For example, here are some lesser-known small caps that have some of the qualities needed to see some enormous gains:

*Data taken from Capital IQ, a division of Standard & Poor's. TTM = trailing 12 months.

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 to get started.

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This article was originally published on October 16, 2009. It has been updated.

Fool contributor Jordan DiPietro owns no shares mentioned above. Chesapeake Energy and Microsoft are Motley Fool Inside Value selections. Under Armour is a Motley Fool Rule Breakers pick. Under Armour is a Motley Fool Hidden Gems choice. Motley Fool Options has recommended a diagonal call position on Microsoft. The Fool owns shares of Chesapeake Energy, and Under Armour, and has a disclosure policy.