Two Ways to Find Winners

Activision (NASDAQ:ATVI) and Affiliated Managers Group (NYSE:AMG) are two companies that don't have a lot in common, except that they were the two stocks recommended by David and Tom Gardner, respectively, in the September 2002 issue of Motley Fool Stock Advisor. That issue -- published at the very depths of the bear market -- saw David and Tom scouring the market for very different traits in their search for superior investment returns. And both picks have worked out well. Activision is up more than 120% and AMG is up almost 150%. That's incredible performance for both companies, but I'll hear from Tom if I don't point out that he is the month's stock-picking champ. (He's also leading overall, beating David 68% to 56%.)

Those returns are all well and good, particularly since they've beat the market four and five times over during the same time span, but it's been nearly three years since the stocks were recommended. Let's go back to the original recommendations to figure out which stock is most likely to win in the long run.

Assessing Activision
David picked Activision because it was a profitable company with strong brands in the growing interactive entertainment industry. As an early adopter himself, David saw that Activision had positioned its brands, including Doom and Tony Hawk, nicely for the future. Moreover, the company was growing sales, earnings, and cash flow every year.

Since David made his recommendation, the video-game business has become even more like the movie business with every passing generation of consoles. Games that used to cost six figures to produce can now cost $5 million, and those costs will probably rise when Xbox Next and PlayStation 3 come on the market in the near future.

Those rising costs will help Activision further consolidate its position going forward. While it used to be that computer games were revolutionized nearly every year by a team of creative and smart programmers working on small budgets, the rise of the blockbuster game has substantially raised the barrier to entry. Activision is one of the few firms that can afford to control its niche, along with California-based Electronic Arts (NASDAQ:ERTS), also a Stock Advisor pick. Other competitors include Take-Two (NASDAQ:TTWO), Midway (NYSE:MWY), and Atari (NASDAQ:ATAR).

Activision is a classic David Gardner recommendation. It's a leader in a growing industry with the brand potential to take over an extremely lucrative market. The upside is huge if gaming grows as projected and Activision maintains its market share. The risk, of course, is that the company will cease designing games good enough to drive growth.

As for Affiliated Managers .
Affiliated Managers was a gutsy recommendation to make back in the bear market of 2002. The company -- the parent of a number of venerable money management firms, including Third Avenue and Tweedy, Browne -- was already 60% off its 52-week high, and Tom was asking subscribers to invest in a business whose future hinged on success in the stock market. The unwillingness of other investors to concentrate their investment dollars in that way was likely the reason AMG had fallen so far in the first place.

But Tom's contrarian impulse was spot-on. Despite the economic downturn at the time, he saw that the bear market had only mildly eroded AMG's top and bottom lines. Moreover, if you were to factor out the company's exceptional performance in 1999 (a year when the market was going gangbusters), it was easy to see that AMG was still walking a path of solid growth.

Tom found a well-managed cash machine selling at a bargain for no good reason, and it has had a very profitable run for subscribers. It's a classic Tom Gardner pick that focuses on superior management, a well-run business, and cold hard cash.

Carnac says
Since we can't travel back in time and purchase either one of these firms at the price at which they formerly sold, let's see if we can't figure out which one will be the bigger winner going forward. First, here are the financials as they stand today:

*Numbers in millions, except EPS.

Affiliated Managers is a cash monster, and its substantial debt position is actually an asset to the company as long as its funds return more than the company pays in interest.

In addition to Activision's Doom and Tony Hawk brands, the company recently expanded its licensing agree with another Stock Advisor pick, Marvel (NYSE:MVL), to include characters across that company's 5,000-strong universe. The company has already had success with Spider-Man, X-Men, and the Fantastic Four.

Since both companies currently trade at P/Es greater than 30 (rich for their industries) and are transitioning from their high-growth phases, neither represents a great bargain right now. That said, Activision should eventually pull ahead in this race and reward investors over the long run -- particularly after the cash-laden, debt-free company declares a dividend, which it shouldn't put off paying for much longer.

More and more people around the world are both investing and playing video games, but while gamers will always need software to play, investors are more likely to use services such as The Motley Fool to invest on their own, thereby capping the potential growth of mutual funds. So my vote here is for David.

Foolish final thoughts
That's just my opinion. If you'd like to see what the brothers think, consider a 30-day free trial to Motley Fool Stock Advisor. Though they have different investment strategies, both are soundly beating the market. (Tom's up 68% to David's 56%, remember, and both are walloping the market's 17%.) They use those strategies to identify two companies per month for subscribers, and if you click here right now, you'll be able to access today's brand new issue when it is released at 4:00 this afternoon. There is no obligation to subscribe.

David and Tom may compete against each other, but you win no matter what.

Tim Hanson owns none of the companies mentioned in this article. At The Fool, no writer is too cool for disclosure ... and Tim's pretty darn cool.