This Investing Secret Will Make You Rich

I consider myself a pretty rational investor. I mostly look for value stocks, companies trading cheaply with a history of success. However, I do like to take risks -- I just make sure the risks are weighed in my favor.

Can we all be geniuses?
I admit it -- sometimes I have delusionary thoughts of myself as Matt Damon in 1997’s Good Will Hunting. As I’m casually impressing women with my thoughts on the evolution of market economies and the capital-forming effects of military mobilization, my friend turns to a nearby female and says in the heaviest of Boston accents, “My boy’s wicked smart.” And of course on top of that, I’m self-taught in algebraic graph theory and high finite mathematics.

But let’s get serious -- that ain’t happening for me, and I certainly can’t promise you mathematical genius. But I can show you how the simple tenets of game theory have continually helped companies strategize for success, and how you can use those same doctrines to make astounding stock picks. 

Game theory
When applied to business, game theory shows how companies can benefit from focusing not just on themselves, but on others. It urges management to look forward, and then reason backward. It promotes cooperation, not just competition.

As Adam Brandenburger and Barry Nalebuff write in Harvard Business Review, "successful business strategy is about actively shaping the game you play, not just playing the game that you find."

When applied to investing, game theory helps you distinguish between the two types of companies out there: those that are breaking the rules, and those that are just playing by them. Let’s focus on three methods companies can use to reshape the game in their favor:

• Changing the players of the game
• Changing the added value of the players
• Changing the rules of the game

Game-changers of the past
Here are three companies that have used these tactics very successfully:

• Changing the players: Thanks to NutraSweet’s household-name status in the 1980s, Coca-Cola (NYSE:KO) used the low-calorie sweetener exclusively in its products. As NutraSweet’s patent was due to run out in 1987, Coke urged the Holland Sweetener Company (HSC) to enter the market. After HSC built a sweetener plant, NutraSweet’s manufacturer announced deep price cuts, and Coke signed long-term contracts with NutraSweet that all but put the smackdown on any future for the Dutch company. Didn’t Coke want another possible supplier? Nope. What they wanted was NutraSweet -- the brand consumers were familiar with -- at a lower price. Coke advocated a new entrant only to act as a threat to NutraSweet, and the result was an estimated savings of $200 million annually for Coke and PepsiCo.
• Changing the added value: In 1985, video game maker extraordinaire Nintendo swiftly became popular in the U.S. with the introduction of Super Mario Bros. However, the game’s value to Nintendo was limited because it couldn’t compete with the buying power of the mega-retailers it sold to, like Wal-Mart (NYSE:WMT) and Toys R’ Us. So in 1988, Nintendo sold 33 million cartridges, even though the market could have easily soaked up 45 million. Nintendo-mania consumed kids across America, and angry parents waiting in line began cursing the ill-equipped retailers. With games now in short supply, Nintendo was able to add extra value to its products, shifting the power structure dramatically.
• Changing the rules: As of late 2007, the average U.S. company spent 4.5% of its revenue on R&D -- and even though most companies continue to internalize R&D and spend boatloads of cash every year, one company decided to play by its own rules. In 2006, Netflix (NASDAQ:NFLX) offered a $1 million prize to anyone who could improve the accuracy of its movie recommendations by 10% or more. For a paltry $1 million, the company is due to reap huge rewards both operationally and from media attention. Already, the company has announced a Netflix Prize 2, with more money and some “new twists.” Rules for R&D -- what rules?

Not coincidentally, each of these companies has crushed the market over those respective time frames: 

Sources: Morningstar, Yahoo! Finance. *20 years; **10 years; ***3 years.

Finding the new game-changers
David Gardner, Fool co-founder and advisor of our Rule Breakers newsletter, believes in a lot of the same principles of game theory. Among the many stocks that David suggests, he looks for:

• Top dogs or first movers
• Companies that boast disruptive innovation
• Visionary leadership

So we’ve established that the most successful companies are those that can shape their own futures, constantly innovate, and change the rules. Here are just a few that we’ve recommended recently:

• OpenTable (NASDAQ:OPEN) is the principal supplier of comprehensive reservation and guest management software for restaurants. OpenTable is not only a first mover -- it changed the players of the game by being the first and only public company to do what it does.
• First Solar (NASDAQ:FSLR) is the cheapest provider of solar panels at $0.92/watt. By investing in cadmium telluride as opposed to polysilicon, First Solar has produced thin film cells that provide added value to its customers and continue to be a disruptive force in the overcrowded solar industry.  
• Green Mountain Coffee Roasters (NASDAQ:GMCR) had the visionary leadership to see beyond the standard dine-in Starbucks (NASDAQ:SBUX) business model. It is now the leading pioneer and manufacturer in single-cup brewing systems, also focusing on e-commerce and direct mail.

David and his team have found more great stocks to invest in. Like the above companies, they show visionary leadership and the ability to shape the game instead of just the ability to play in it. The team is focusing particularly on cutting-edge fields like biotech, alternative energy, and nanotechnology. If you’re interested in seeing their past and present recommendations, click here to try the service free for 30 days.

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Fool contributor Jordan DiPietro owns shares of First Solar. First Solar, Green Mountain Coffee Roasters, and OpenTable are Motley Fool Rule Breakers recommendations. Netflix, Nintendo, and Starbucks are Stock Advisor picks. Coca-Cola, Starbucks, and Wal-Mart are Inside Value picks. Coca-Cola is also an Income Investor recommendation. Nintendo is a Global Gains pick. The Fool owns shares of Starbucks. The Fool's disclosure policy is the No. 1 fan of Nintendo’s 8-bit Marble Madness.