Have you ever listened to an interview with a supermodel?
And no, I don't mean watched an interview, I mean listened to one. Almost invariably, the supermodel recalls her awkward years in high school. Occasionally, the years were so awkward, she didn't get asked to the prom.
It wouldn't have taken a Casanova to score a date with a supermodel back then. Years later, even Casanovas get turned down.
This same kind of bad timing can kill your portfolio's returns.
The supermodel stocks
Since my job is analyzing and writing about stocks, I talk to a lot of people about stocks -- from folks who can barely spell the ticker symbol to folks who have multitab spreadsheets on each company they follow. But this motley assortment has one thing in common.
Everybody, and I mean everybody, has an opinion on Pepsi
Unfortunately, they're kinda late to the party. Wall Street is all over these companies. Pepsi has 15 analysts covering it, Target has 23, and Amazon has 33.
To be clear, those analysts cover these companies and their industry competitors as a full-time job; they're laser-focused on knowing everything they can about just a few companies. While you're making toast in the morning, they're updating proprietary models. When you're meeting with your boss, they're meeting with CEOs. Printing out one of their research reports will get you on the Sierra Club's watch list.
You get the idea.
Wall Street's weakness
Now, that doesn't mean you can't make money on these stocks. Wall Street is known for following the herd and thinking in quarters instead of years. You can surely exploit these Wall Street weaknesses. Heck, that's what we try to do every day at The Motley Fool.
However, focusing just on the big guys misses Wall Street's biggest blind spot. Analysts are very well-compensated, so covering the little guys -- the ones fewer people have heard of -- just doesn't make sense from a cost-benefit perspective.
And that leads to opportunity for the individual investor (read: you).
Just look at the differences in the amount of coverage the following stocks receive:
|
Small, Underfollowed Stock |
Number of Analysts |
Well-Known Stock |
Number of Analysts |
|---|---|---|---|
|
inVentiv Health |
4 |
WellPoint |
20 |
|
Drew Industries |
5 |
Toll Brothers |
18 14 |
|
Dawson Geophysical |
3 |
BP |
12 29 |
Three times as many professional analysts follow the big homebuilders as follow Drew Industries, which makes components for RVs and manufactured homes. It's even more lopsided for Dawson Geophysical and inVentiv Health.
Keep your eyes open
Now, just because a company is underfollowed doesn't mean it's a diamond in the rough just waiting to be discovered. In fact, there are plenty more bad, unfollowed companies than good.
The trick is to do the work that Wall Street either can't or hasn't.
The team at Motley Fool Hidden Gems recommends looking for the following characteristics to separate the gems from the garbage:
- Strong balance sheets.
- Strong free cash flow.
- Sustainable competitive advantage.
- Smart management that has proper incentives.
After identifying these companies, the next step is buying in at a good price.
The Hidden Gems team does this for the world to see. It searches for the small, ignored stocks that will be tomorrow's supermodel stocks; it then invests The Motley Fool's own cash in a real-money portfolio. Each month, the team identifies two new portfolio candidates, but doesn't buy shares until the opportunity for returns gets sufficiently juicy. So far, inVentiv Health has made the cut, but Drew Industries and Dawson Geophysical haven't. To see all the companies the team has bought, click here for a free 30-day trial.
This story was originally published Dec. 18, 2009. It has been updated.
Anand Chokkavelu does not own shares in the companies mentioned in this article. He wonders: If your next-door neighbor were a supermodel, would she have supermodel looks or girl-next-door looks? Drew Industries, Dawson Geophysical, and inVentiv Health are Motley Fool Hidden Gems selections. WellPoint is an Inside Value recommendation. inVentiv Health is a Stock Advisor pick. PepsiCo is an Income Investor recommendation. The Fool owns shares of inVentiv Health and has a disclosure policy.
