Imagine if Harrison Ford was a stock, and you purchased shares of him back when he was building cabinets for George Lucas. Three Star Wars and a couple Indiana Joneses later, you'd be sitting on enormous pile of cash.

Finding small, obscure, real-life stocks before they become Harrison Fords is what the Motley Fool's Hidden Gems service is all about. Specifically, our analysts look for small stocks with one of three attributes:

  1. Great companies that are simply unknown.
  2. Great companies that are facing a temporary setback that is holding share prices down.
  3. Great companies that, for one reason or another, are deeply out of favor.

Using these three guides, the Hidden Gems team has recommended great stocks at great prices. Consider the fact that (Nasdaq: CTRP) -- a Chinese travel site -- was relatively unknown when it was recommended in 2005 and is up 469% since then. Or Fossil (Nasdaq: FOSL) -- a clothing specialist that had fallen out a favor -- which was recommended in 2008 and is up 291% since.

Well, I've got a stock for you today that satisfies not one, but two of the criteria of a Hidden Gem: Lumber Liquidators (Nasdaq: LL)

Deeply out of favor
Though LL itself may not be deeply out of favor, just about anyone associated with housing or real-estate is. How bad are things in this sector? The S&P's Homebuilders ETF (NYSE: XHB) is down more than 60% since its high in 2006. And while the broader is down just 9% since the beginning of 2007, the Homebuilders ETF is down 53%.

Facing a temporary setback
Since the hardwood retailer first opened in 1994, LL has used a hodge-podge of methods to account for inventories and fulfill orders. Most often, this involved using Excel spreadsheets. With an eye on the future, the company realized it needed to modernize its records; in mid-2010, it chose to install a new management system from SAP (NYSE: SAP).

Management hoped that the new system would allow for faster and more efficient distribution of supplies.

The results after one quarter? Disastrous.

Instead of enduring a simple change in electronic management systems, the company essentially had to learn a new language. LL employees, who had previously been using Excel, had to adjust to a completely different system. Management underestimated the difficulty of seamlessly learning the new system; it subsequently reported horrendous earnings in November 2010.

Reasons for optimism
Subsequent earnings statements have shown that LL seems to be getting past its growing pains. One of the biggest problems with the SAP switchover was that customers were ordering hardwood flooring, but Lumber Liquidators was unable to deliver the product in a timely manner. In a move that hurt them in the short term, but was no doubt good for the long run, LL gave discounts to their customers for the added troubles. I like seeing a company that's willing to endure this kind of short-term pain for long-term gain.

In addition, the management team has added a new blood, with COO Robert Lynch and Chief Merchandising Officer Bill Schlegel coming onboard. They both have background in improving supply-chain management, and they've already improved gross margins by 80 basis points since January.

By finally benefitting from the SAP system, and focusing solely on hardwood flooring, the company can undercut competitors Home Depot (NYSE: HD) and Lowe's (NYSE: LOW) moving forward.

Foolish takeaway
Only time will tell whether Lumber Liquidators ends up being the monster stock I think it can be. If you would like to investigate further into the world of small cap investing, I'm going to offer you access to a special free report, "Too Small to Fail: 2 Small Caps the Government Won't Let Go Broke." Inside, you'll find a full report on two small cap stocks that have lots of room for growth and government backing to help reduce the risk involved. It's yours, absolutely free, just by clicking here.

Fool contributor Brian Stoffel owns shares of Lumber Liquidators. The Motley Fool owns shares of Lumber Liquidators Holdings, Fossil, and International. Motley Fool newsletter services have recommended buying shares of Lumber Liquidators Holdings, Home Depot, International, Lowe's, and Fossil. Motley Fool newsletter services have recommended writing covered calls in Lowe's.

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