Our goal in Hidden Gems is to find the best small companies to own for the next three to 35 years. It's a wonderful aim, since historical data illustrates that small-cap stocks -- particularly of the value variety -- have substantially outperformed the overall market over the past 40 years.

To optimize our returns, we look to sell our mistakes quickly, hold sound companies for an average of three years, and then, yes, maintain our stakes in the very best of the lot for a quarter century or more. The best time to sell shares of a truly superior small company is almost never. Selling Lowe's (NYSE:LOW) or Home Depot (NYSE:HD) in the early days after doubling your money would have wound up costing you dearly, as both continued to crush the market as the years rolled by.

It's been 17 months, and our Hidden Gems cumulative returns thus far are gratifying. Tom's recommendations are up an average of 46% and our guest analysts have an average return of 38%, while equal amounts invested in the S&P 500 over that time would have returned an average of 11%. There's no question that we'll have down periods. Recessions can be nasty for small-company stocks. But over time, we expect to outperform the general market by buying and holding onto the next wave of great American companies.

How do we find them? Think Wal-Mart
One way to find the future greats is to carefully study the major winners from the past. Relatively few of the multidecade superstars are technology companies. And while we don't avoid tech stocks in Hidden Gems, they are a minority of our selections, as we favor instead sleepy and underfollowed companies with high-quality management. Our sleepy, boring successes thus far include commercial oven maker Middleby (NASDAQ:MIDD) and Mine Safety Appliances (NYSE:MSA), which makes health and safety products.

But for the ultimate example, think Wal-Mart (NYSE:WMT).

In November 1980, Wal-Mart was trading at a split-adjusted $0.01 per share. That's right, one cent. But let's be clear: The stock was selling at $50 per share then, so it wasn't ever a penny stock. In our opinion, it's actually nearly impossible to become a penny-stock millionaire -- the mischievous title we placed on this article. No, the greatest stocks are those of real companies, with real earnings. Because of stock splits, some investors think you'll find the next Wally World searching among 30-cent stocks. You won't.

So what has Wal-Mart done since 1980 (a full decade after it went public)?

With the stock trading at $52.75 as of this writing, it has risen 5,275 times in value over the past 24 years. A $5,000 investment back then is worth more than $26 million today. That'll clean up a lot of investment mistakes!

But what if we go all the way back to Wal-Mart's IPO, when it became a public company in October 1970? The business was valued at a tiny $21.5 million then. That means the stock is up more than 13,000 times since. That's more than 30% growth per year, and would have turned a $5,000 investment into $65 million today.

When the company came public, it raised $4.5 million in cash to pay down debts. Wal-Mart was nothing back then. No one knew it. Hardly anyone followed it. And none of the big boys on Wall Street really cared about it. And that plays right into Hidden Gems' sweet spot.

Reverse engineering a superstar
Now it's time to pick out the qualities of what has been one of the greatest 25-year investments in the history of our species. Here are the traits of Wal-Mart in its early days, which we intentionally look for in Hidden Gems:

  • After just a few years in the public markets, it began paying a dividend and never stopped -- amazing for such a tiny company.
  • Related to that point, its dividend started in the teeth of a bear market in the early 1970s -- very telling about the strength of the financials even in trying times.
  • Wall Street treated the company like a bunch of hillbillies in Arkansas. For years, no analysts followed it.
  • Institutional ownership was well below 50% for years and years. As we said, hardly anyone cared.
  • Sam Walton owned the majority of the stock. Here was a founder with a stake in the organization's enduring success.
  • Its concept was new and innovative, yet proven. Wal-Mart had been in business for eight years before going public, with more than 30 stores and over $32 million in sales on the day of its IPO.
  • It had a compelling valuation, trading at just 0.67 times sales when it came public.

Find the next oneh
We're not trying to reinvent the wheel here in Hidden Gems, because we simply don't need to. There's something on the order of 100 years of researchable history of the U.S. stock markets, and tons of data available over the past 25 years. The Internet makes much of the research relatively quick and easy.

There are also numerous masters who have shared fully formed ideas on how to earn extraordinary returns in small caps -- from Peter Lynch to Charles Royce to Warren Buffett to Martin Whitman. By combining our research capabilities with the outstanding principles these folks have handed down, there's a lot we can do together to increase your wealth over the long term.

And so, this is the aim of our Hidden Gems community every day, with thousands of members working together and examining the more than 7,000 public companies capitalized under $500 million. We have no doubt we'll find some of the market's major winners over the next three to 35 years. Panning for the next Nike (NYSE:NKE) or McDonald's (NYSE:MCD) is our full-time work and mission statement.

If you'd like full access to our service for a trial run of 30 days, let us know. It's free, and there's no obligation. You can see our first 25 investment recommendations, with full details on each, in our search for the next Wal-Mart-like winner.

Tom Gardner is co-founder of The Motley Fool and heads up the Hidden Gems newsletter. Rex Moore is a Hidden Gems analyst. Neither owns any companies mentioned in this article. The Motley Fool is investors writing for investors.