Every investor has dreamed of finding great companies that will provide superior returns over long periods of time. Unfortunately, the only way that most investors have devised to find such companies involves time travel. In short, you identify successful companies like the AOL division of Time Warner
Let's face it. By the time most of us realize a company will be successful, we've usually missed out on a significant part of the investment return. It's an illustration of a basic rule of efficient markets: When market participants have differing amounts of information, inefficiencies exist that can be exploited by more knowledgeable investors, until their actions incorporate the new information into the price.
Many economists point to the huge array of available economic data, company information, and stock analysis in the modern financial world, and conclude that there are relatively few inefficiencies in the prices of most stocks. Consider, for instance, how much attention the stocks of large companies receive from professional stock analysts. Nearly 30 analysts follow communications company Verizon Communications. Fifteen analysts have provided estimates of next year's earnings for energy giant ExxonMobil
That doesn't mean you can't make money investing in popular companies. Many people stick with well-known names and earn solid returns that meet their needs. However, if you're looking for truly exceptional returns, you have to consider focusing your research on the road less traveled.
For every big-name blue-chip company, there are a dozen small companies that few people have ever heard of. Their stock prices are listed in big financial newspapers every day, and it's just as easy to pull up a stock quote on them. However, because there are thousands of these small companies, many of them remain invisible to the mainstream analysis provided by major Wall Street firms and other data sources.
If you've ever looked at one of these companies, it's easy to see why they don't get followed. It takes a lot of effort just to get basic information about them. If you've got a question about a big company like Oracle
Seeking the final frontier
Although the dreaded "no data available" message from your preferred information source may convince you to turn to more widely followed stocks, it's one of the starting points for two of the Motley Fool's monthly newsletters. The Motley Fool Hidden Gems newsletter searches for tomorrow's stock blockbusters today, focusing on small, promising companies that haven't yet reached the computer screens of Wall Street analysts. By identifying undervalued and underappreciated stocks before they're discovered by mainstream investors, Tom Gardner and his team of Hidden Gems analysts seek to take advantage of pricing inefficiencies in the small-cap market. They're aiming to get you in on the ground floor of what may be the most lucrative investments of the coming decade.
Similarly, while the United States has a well-regulated securities system that requires American companies to disseminate substantial amounts of financial information to the investing public, companies based elsewhere do not always face the same requirements. While this lack of information presents a challenge to interested investors, it also creates an opportunity for those willing to work harder to find good investments. The Fool's Bill Mann took advantage of such an opportunity in post-Soviet Siberia in the 1990s, making money and gaining experience along the way. Now he's launched a newsletter, Motley Fool Global Gains, to help you overcome the difficulties of identifying the best prospects for explosive growth. He expects to continue to find numerous situations in which lack of information creates market inefficiencies that he and his readers can exploit for their benefit.
High risks, high potential rewards
Market inefficiencies are a two-edged sword. Although an information vacuum creates profit opportunities for those who can find accurate information, you also face the risk of gathering incorrect or fraudulent information that will lead you to make bad decisions. Because of the higher risks associated with smaller companies and foreign businesses, most investors should probably limit such investments to a fraction of their overall portfolio.
Nevertheless, there are few things more satisfying than being the first to find a company that turns out to be the next 10-bagger. The best place to look for those companies is where no one else is looking. And a free 30-day trial to the Global Gains or Hidden Gems newsletters may be the right place to start.
This article was originally published on Nov. 7, 2006; it has been updated.
Kristin Graham updated this article, originally written by Dan Caplinger, and doesn't own shares of any of the companies mentioned in it. Time Warner and Dell are Stock Advisor picks; Dell and Microsoft are Inside Value selections. The Fool's disclosure policy applies worldwide.