Last Friday, we discussed the limitations of fundamental analysis and the leap of logic that forces people to try to use past events as predictors of the future. They help, of course, and can and should be heavily relied upon as gauges of management effectiveness, innovation, and profitability. But a view of the past is only part of the story.

When you buy a stock, you buy the future cash flows of that company. Now, just because the future is unpredictable does not mean it is random. Think of it this way: When you add cream to a cup of coffee, it swirls around in an unpredictable pattern -- but not a random one. It would be impossible, for example, for all the cream to congregate on one side of the cup. Stocks are not random either; they are just extremely unpredictable, increasingly so the shorter the time frame considered.

It's sort of like those NCAA basketball tournament games each March. Wanna-be game pickers can have all of the probability statistics you want -- a "#15 seed" only beating a "#2 seed" three times in the history of the tournament, for example. Those who know this stuff may have a slight probability edge, but probabilities have no actual influence on the games when they are played.

Past performance would not have helped you pick Hampton, a small Virginia school participating in the tournament for the first time ever, over Iowa State, a basketball powerhouse. In fact, it's safe to say that Iowa State will win the game on paper nearly every time. They don't play the game on paper, though, and when it counted this year Hampton won -- to the consternation of the 99% of all pool participants who bet on them to lose.

In this case, Hampton had the potential to win, though it was infinitesimally small. I'd suggest that the vast majority of those who picked them to win got lucky. Within the entire tournament, there were much better picks for upsets, even though many of them did not happen.

Fortunately, the stock market offers a non-binary form of verification. Investing isn't an all-or-nothing endeavor like the basketball tourney. Companies don't miss earnings and suddenly drop to zero, though it may currently feel that way. So while biological investing may force you to invest in companies that turn out to be losers long-term, it may also help you to net out that rare AOL Time Warner (NYSE: AOL) that, over times, makes up for many a loser.

Rating a stock's potential can be looked at in the same way that traders evaluate call options, which is the right to buy a stock during a certain time period at a certain price. Some exchange low risk for high cost, but there are some cheap, out-of-the-money calls that entail much higher risk and potential reward. The downside of options is that they have time stamps, so even if you guess correctly, your timing may be off. No such time limitations exist with equities.

So what should an investor look for when looking to make a biological investing decision? One or more of the following would help.

1. An inefficiently served market. From time immemorial, I have remained highly disorganized. From college onward, I kept a day timer notebook to help me out. Mine was a Franklin, produced by a company that has become Franklin Covey (NYSE: FC). The other big player was Day Runner (OTCBB: DAYR).

My planner was great, but it was frightfully expensive, bulky, and it had a tendency to attract and collect other random paper. These products were helpful, but not ideal. Enter the Palm Pilot, put out by 3Com (Nasdaq: COMS), later spun off into its own company, Palm (Nasdaq: PALM). While Palm has yet to provide investors with huge rewards -- at least partially due to its former status as the only component of 3Com that was not performing dismally -- it has absolutely decimated Franklin Covey and Day Runner's planner markets.

So while Day Runner stock appreciated by 500% between 1995 and the beginning of 1999, in the last two years it has lost 99.6% of its value.

2. A displacing technology. Danger, Will Robinson! This is the area where many "tech investors" have been sold a bill of goods in the recent past. It seems that every communications technology that has come out of the gate over the past three years has been touted to the high heavens as having the potential to revolutionize an industry.

B2B platforms, DSL, Iridium and every product ever sold by Ronco are examples of promising technologies that got hyped to the clouds. None have proven world-shaking. Cellular phones, meanwhile, showed the promise to profoundly change how people communicate, and those who invested even as late as 1997 -- well after the industry achieved critical mass -- have done quite well. The companies that provide third-generation or wireless broadband services and technology hold the potential of providing the same returns to investors, though at this early stage these companies are a long way off from realizing this vision.

3. Anti-social behavior. When Microsoft (Nasdaq: MSFT) negotiated its original operating system deal with IBM (NYSE: IBM), it did not play nice. When 3Com released the first Palm Pilot, it was not seeking to integrate its product into the paper-based planners. Rather, Palm Pilots relegated the planners to the historical trash heap. Wal-Mart (NYSE: WMT) has been criticized and resisted in many localities because of the negative effect it had on mom-and-pop shops, which were unable to compete. The biologically superior companies generally ignore or co-opt the existing infrastructure.

Who's doing it now? FOOL 50 component Enron (NYSE: ENE) is one, as it has transformed the natural gas contract process and seeks to do the same with broadband. Micromuse (Nasdaq: MUSE) fits this description, as its software suite is designed to fundamentally change the way telecom carriers provision circuits for their customers. These companies may not succeed, but should they do so it would necessarily mean a significant shift of market power to them and away from the status quo.

4. "Overvalued" stock. This is yet another easily abused notion, as if this last year taught us anything it should be that absurd multiples do not necessarily equal superior companies.  A biological screen for companies is going to fail to eliminate high-priced companies.

Where there is a discernable potential for outperformance, there will also be a premium to be paid.  The danger here is that the price may represent the best-case scenario or better, completely discounting potential  failure, or even difficulty.

We should not, however, expect to be among the first people to discover that a company has superior prospects. Those who get there before us with the same conclusion should, as smart investors, hold on to their shares with a death grip, thus making the remaining shares available for sale just that much more dear.

There are, of course, a myriad of companies that have superior prospects, even if they do not currently reflect it on their bottom line as of yet. We can't guarantee that you will find one or more of them, nor can we guarantee that if you find such a company, something in the future will not go horribly wrong.

What we can guarantee is that a biological analysis of company prospects, objectively done, will give you the keys to learning how commerce works -- and thus a greater chance of recognizing a diamond in the rough when you see it.

Fool on!

Bill Mann, TMFOtter on the Fool discussion boards

Bill Mann has never been called for goaltending. At time of publishing, Bill did not own any of the companies mentioned in the article. To see Bill's holdings, please view his profile. The Motley Fool is investors writing for other investors.