Why This Stock Is a Winner

If you could wave a magic wand and bestow just one characteristic on all of your investments, what would it be? (Besides the ability to print money, that is.)

I began thinking about this after reading Tom Gardner's "A 25-Bagger in Five Years," in which he identified three things that give a company the chance to achieve outsized gains over the years -- like 25-baggers that turn $5,000 into $125,000. Of the three he mentions (which are actively screened for at Motley Fool Hidden Gems), one characteristic is most important to me: a high level of insider ownership.

Why it matters
But this makes sense, right? Think about any of your major personal investments:

1. You are a stockholder, with a good deal of your wealth riding on this company's performance.
2. Founders and managers with high levels of ownership also have their wealth riding on the company's performance.
3. They are doing everything they can to increase the long-term value of their stock -- of your stock.

Having a wonderful time ...
With their reputations, their livelihoods, and their careers on the line, you can be fairly sure these managers and board members are motivated to do what's best for the company. It's like having someone on the inside, working for you. Every day.

What is the opposite of that? Businesses where management has very little tied up in company stock. Where actions may be motivated by things that actually harm the stock's performance, like office politics, power plays, or working more with an eye on the clock (is it 5:00 yet?) than on improving the business model. Or, even worse, management that rewards itself with high salaries and bonuses that have nothing to do with outstanding performance.

But smaller companies overall are a much different story. In small-cap land, CEOs and managers with high levels of ownership are much more likely to rise above the mediocrity and work toward the common goal of great stock performance.

For instance
I ran a screen for companies with high insider ownership, but went a bit beyond that. The following businesses also have high margins and returns on equity, and have been able to generate sales and earnings growth over the past year -- a potentially winning combination.

Company	Insider Ownership	Sales Growth*	EPS Growth*	Net Margin*	ROE*
L&L Energy (Nasdaq: LLEN  )	30%	130%	245 %	26%	54%
China Information Security Technology (Nasdaq: CPBY  )	41%	18%	26%	30%	23%
China Green Agriculture (NYSE: CGA  )	34%	52%	78%	44%	27%
Perfect World (Nasdaq: PWRD  )	31%	49%	77%	48%	52%
Pre-Paid Legal Services (NYSE: PPD  )	11%	0.1%	1%	12%	125%
Buckle (NYSE: BKE  )	44%	13%	22%	14%	37%
Steven Madden (Nasdaq: SHOO  )	11%	14%	76%	11%	24%

Data provided by Capital IQ, a division of Standard & Poor's.
*Trailing 12 months.

And beyond
Insider ownership, especially in smaller companies, is one positive indicator in the quest for tomorrow's multibaggers. There are many more, of course, but it's one of the core variables we screen for in Hidden Gems.

The process is working, and Tom and his analysts are handily beating the market. We invite you to take a free trial and look through all of our active recommendations, including the top five stocks to buy now. There's no obligation to subscribe.

This article was originally published Feb. 21, 2006. It has been updated.

After years of exhaustive research, Rex Moore has determined that a stitch in time actually saves only 8.9997. At the time of publication, he owned no companies mentioned in this article. Perfect World is a Motley Fool Rule Breakers choice. China Green Agriculture is a Motley Fool Global Gains selection. Motley Fool Options has recommended writing puts on Perfect World. The Fool owns shares of China Green Agriculture. The Fool is investors helping investors.