2 Ways to Find Winners

Activision (NASDAQ:ATVI) and Affiliated Managers Group (NYSE:AMG) 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. Since then, Activision has underperformed the market and is up just 30%. AMG, on the other hand, is up more than 220%.

Those returns aside, 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 nicely positioned its brands, including Doom and Tony Hawk, 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 are rising with the arrival of the Xbox 360 and PlayStation 3.

Those rising costs should help Activision consolidate its industry position going forward. Computer games used to be revolutionized nearly every year by a team of smart, creative programmers working on small budgets, but 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 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, and recent financial results that reflected a weak operating environment have reduced Activision's price tag. 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. 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 factored 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's 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:

Affiliated Managers is a cash monster, and its substantial debt position is actually an asset to the company -- so 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 agreement with another Stock Advisor pick, Marvel (NYSE:MVL), to include properties across that company's 5,000-character-strong universe. The company has already had success with Spider-Man, the X-Men, and the Fantastic Four.

Since both companies currently trade at P/Es rich for their industries, and both 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. Today, the environment is about as favorable as it gets for financial firms like AMG. Activision, on the other hand, has been beset by doubt, even though the future for video games looks very bright. Here, my vote goes 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 74% to David's 47%, and both are walloping the market's 22%.) 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 tomorrow's brand-new issue when it's released at noon. There's no obligation to subscribe -- why not give it a try?

This article was originally published August 19, 2005. It has been updated.

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.