In mid-November 2008, I scraped together a bit of cash and made equal investments in five carefully chosen stocks. As of Dec. 1, my portfolio's up roughly 60%, versus an approximately 40% return for the Vanguard Total Stock Market Index (VTSMX) over the same period. How did I clobber the market, at least over the short run? Three principles helped me immensely -- but the last one may have been the most important of all.
(Spoiler alert: I totally lucked out.)
1. Invest in what you understand
With one notable exception, all the companies I chose for my portfolio operated in businesses I could generally grasp, and all had clearly apparent competitive advantages that set them apart from their peers.
I'd been a fan of Chipotle Mexican Grill's (NYSE: CMG ) addictive burritos since my college days, and I'd seen their stores do brisk business in states as far-flung as Illinois and Texas. Neither of its burrito-rolling rivals, Jack in the Box's (Nasdaq: JACK ) Qdoba or privately held Baja Fresh, had the same buzz or name recognition, yet Chipotle's restaurants still weren't as common a sight as many fellow fast-food franchises.
I also knew that unlike just about every other fast-food chain in the country, Chipotle had embraced natural, organic ingredients at a time when sustainable eating was increasingly important to more and more people. Better yet, they'd managed to keep their food tasty, fast, and affordable. Today, Chipotle's more than a two-bagger for me -- and while I'll freely admit that I find that price a tad overstuffed at the moment, I still think the company's future looks muy sabroso.
It's probably no coincidence that the worst-performing investment I chose -- up a mere 17%, which is still nothing to sneeze at -- was Dawson Geophysical (Nasdaq: DWSN ) , which conducts seismic imaging to discover deposits of oil and natural gas. I'd read Fool articles singing this Motley Fool Hidden Gems pick's praises as a well-run company with great management, and I still believe that its fortunes will improve once natural gas prices come out of their slump.
But I won't even pretend to understand what sets Dawson apart from its rivals, other than "it's better." And while I can easily grasp the appeal of a burrito -- and an actual burrito, although for that, I usually need two hands -- the complexities of the natural gas market aren't something I tend to follow.
2. Do your homework
Motley Fool CAPS' amazing array of useful stock data was a huge help to me in deciding which companies deserved a spot in my portfolio. The information it provided helped me look beyond the P/E ratio and other common stats to get a better idea of how my candidates performed relative to their industry peers.
I was leery about buying into Intuitive Surgical (Nasdaq: ISRG ) at first, despite its bona fides as a Motley Fool Rule Breakers pick. I liked the tangible advantages of its surgical robotic technology, its fortress-worthy moat of patent protection, and its promising business model, rich with recurring revenue streams from steady sales of disposable tools for its robo-docs. But Intuitive had a hotshot reputation as a high-priced growth stock, and I wanted to make sure it had some steak to back up its sizzle.
Thanks to CAPS, I could dig deep into Intuitive's numbers and see how it worked underneath all the hype. In particular, I looked at its long-term return on investment, net profit margin, and revenue and net income per employee, and I compared them all to the corresponding averages from Intuitive's industry peers. My research convinced me that Intuitive was an efficient, highly profitable company that had spent the past few years absolutely whaling on its rivals. I pulled the trigger on ISRG with confidence, and the stock has since rewarded me with another two-bagger, and then some.
By now, I'm probably sounding like some swaggering stock jock. But I'm not. I wouldn't enjoy the gains I have today if Mr. Market hadn't handed me a huge (and scary) opportunity.
3. Buy when no one else wants to
Remember where Wall Street was roughly one year ago? That's right: curled up under its trading desk in a fetal position, sobbing quietly. The markets had just plunged spectacularly, leaving just about every stock completely gutted. It seemed people were selling as fast as they could, fleeing equities for the apparent safety of bonds and Treasury bills -- even when those investments' yields were so low, they effectively guaranteed investors a small loss.
In short, it was the perfect time to buy sturdy, well-run companies, and hang on tight.
Like everyone else, I didn't exactly feel optimistic about the economy back then. But my research and reading still left me confident that I could trust my money to top-notch leaders like Costco's (Nasdaq: COST ) Jim Sinegal. This highly motivated founder was heavily invested in his own company, drew a modest annual salary, treated his employees like gold, and pursued customer satisfaction and efficient operations with a zeal that rivals such as BJ's Wholesale (NYSE: BJ ) could only hope to match.
(Also, as I later learned when Sinegal visited Fool HQ, the man bears an eerie resemblance to beloved character actor Wilford Brimley. But that's neither here nor there.)
The market could do what it liked. I had absolute confidence that Sinegal spent every day designing his company to do right by employees, customers, and shareholders for decades to come. My investment in Costco has risen by more than 25% since I bought it, including reinvested dividends. While it's had its ups and downs getting there, I never once doubted its long-term potential.
No, I do not stand athwart the market like a mighty colossus
Am I pleased with my investments? Yes. Do I enjoy the bragging rights? Probably a little more than is good for me. Do I expect my portfolio to keep making a leap this big every year from now on? Absolutely not.
I had the good fortune -- if you can call a borderline economic meltdown "good" or "fortunate" -- to buy in when the market looked bleakest. I don't doubt my stocks will endure a dip or five in the years ahead. But that's OK. As long as I believe in these companies' long-term potential, I'll keep a tight grip on them. And because I bought in when fear and panic had pushed these companies way below their fair value, my eventual returns should be that much higher.
Every month, our Motley Fool Inside Value newsletter seeks out sturdy, successful stocks in exactly this predicament -- beaten down by fear or pessimism to prices that practically scream "bargain!" Heck, I found another stock in my portfolio (not mentioned above) thanks to Inside Value's carefully researched recommendations. Including reinvested dividends, it's up a not-too-shabby 27% for me. If you'd like to see these value hounds' full roster of recommendations, you can try Inside Value absolutely free for 30 days.
(Spoiler alert: You might just be glad you did.)
Editor's note: Contrary to reporting in a previous version of this article, Baja Fresh is a privately held company. The Fool regrets the error.
Ready for the disclosure-a-thon? Deep breath. Here we go. Chipotle and Costco are Motley Fool holdings. Jack in the Box and Costco are Motley Fool Inside Value picks. Chipotle and Intuitive Surgical are Motley Fool Rule Breakers selections. Chipotle and Dawson Geophysical got the nod from Motley Fool Hidden Gems. Costco is a Stock Advisor pick. Nathan needs to go lie down now.
Fool online editor Nathan Alderman is as mystified as you are. He owns shares of Dawson Geophysical, Intuitive Surgical, and Costco, and B-shares of Chipotle, but holds no financial position in any of the other stocks mentioned in this article. If you're curious, see all the stocks he owns. All the numbers and percentages cited here applied as of Dec. 1, 2009. The Fool's disclosure policy is humble to a fault.