3 Stocks for the Patient Investor

Back in the 17th century, Sir Isaac Newton famously said that his great achievements were made possible by the fact that he "stood on the shoulders of giants."

No, this wasn't a gaggle of Gulliver's Brobdingnags, but rather giants of the mind: great scientists and mathematicians -- both Newton's predecessors and contemporaries -- who not only taught him fundamentals, but also challenged his mind to go one step further. The upshot is that even a natural genius like Newton didn't achieve mastery on his own. He had help.

Like Newton, we too must seek out the giants in our field if we plan to become master investors. And when it comes to investing in small-cap companies, the first giant I look to for a boost is Chuck Akre, manager of the Akre Focus Fund.

Is he a baby giant?
Although the Akre Focus Fund only launched in September, Akre's been in the business 40 years. He recently opened up his own fund after resigning as a subadvisor and the founding manager of the very successful FBR Focus Fund.

During his 13-year tenure at FBR Focus, the fund generated 12.6% annualized returns and never trailed the S&P 500 in any rolling five-year period. That is, in a word, impressive. And it's proof enough that Akre is a giant worth listening to.

So what's Akre's secret to finding great stocks? According to his firm's website, it's as simple as:

• Select investment opportunities to preserve and grow capital.
• Develop a focused portfolio that seeks to identify "compounding machines."
• Invest for long-term results, recognizing that volatility can create powerful opportunities.

Of course, nothing is as simple as it sounds. The first and second principles -- essentially finding companies with strong returns on capital and top-flight management trading at attractive valuations -- is difficult enough, but as we all found out during last year's panic, it's the third principle -- patience -- that's the most challenging for us individual investors.

Simon says
Raise your hand if you hastily sold an otherwise good investment during the market downturn. C'mon, fess up.

Yeah, I did, too. It's a mistake I've learned from and hope not to make again, for it's precisely because the small-cap market is less-followed, less-liquid, and more-volatile than large caps that you need to have patience on your side. It can take years -- not months -- for your investment thesis to play out -- and for other investors to climb on board. 

Akre lives this principle -- at the time of his resignation, the highly successful FBR Focus fund had a portfolio turnover rate of just 17, meaning the average holding time for securities in the portfolio was just over five years, years which saw both low volatility and high volatility.

To put this figure in some perspective, the average domestic mutual fund has a turnover rate near 100% (or an average holding period of one year), which doesn't even sound all that bad when you consider how frequently the shares of these major companies turn over:

Source: Yahoo! Finance, as of Feb. 22, 2010.

41 days? 55 days?! That's not investing -- it's a game that, as small investors, we simply can't win, nor should we really want to.

What's the small investor to do?
In a recent shareholder letter, Akre gave some advice for the small investor: "So, you ask, 'What do we do now?' Or perhaps, 'How should we be thinking about our investments?' The individual investor has a great advantage, in that he is able to think 'long term.' ... We also believe that the only thing to focus on is the fundamentals of the individual assets (stocks, bonds etc.)."

So let's focus on some fundamentals. Taking a page from Akre, I screened for companies with:

• Market caps between $100 million and $2 billion.
• Return on capital greater than 15% in each of the past three years.
• Insider ownership greater than 5%.
• Price-to-earnings ratio under 20.

Here are three of my results:

Source: Capital IQ, a division of Standard and Poor's, as of March 23, 2010.

It's an intriguing group of stocks. Almost Family offers at-home health-care services, Pre-Paid Legal does what its name implies, and China Sky One Medical sells over-the-counter nutritional supplements in China. Each company faces its own unique set of risks, but are worth further research given their modest valuations relative to their ability to generate returns on capital. In short, they're ideal portfolio candidates for the patient investor.

Foolish bottom line
As individual investors, our two greatest advantages over the large institutional traders are our ability to be patient and finding overlooked small companies. By making better use of the unique advantages we have, we stand a much better chance of achieving long-term investing success.

If you're committed to becoming a more patient and focused investor, you've now got three stock ideas to get you started. If you'd like even more guidance, we're offering a free guest pass to Motley Fool Hidden Gems for the next 30 days. Just click here to get started.

This article was originally published Dec. 24, 2009. It has been updated.

Fool analyst Todd Wenning applauds Ted Danson's masterful work in the 1996 made-for-TV version of Gulliver's Travels. Todd does not own shares of any company mentioned, but owns shares of the Akre Focus Fund. Intel and Sprint Nextel are Motley Fool Inside Value selections. Apple is a Motley Fool Stock Advisor pick. The Fool has created a covered strangle position on Intel. Motley Fool Options has recommended a buy calls position on Intel. The Fool owns shares of Almost Family and has a disclosure policy as wise as an old owl.