4 Steps to Uncovering the Market's Best Ideas

A well-accepted technique for uncovering great stocks has been to follow the portfolios of great investors. So, is the opposite also true? Can we discover star investors by unearthing the shareholders of stellar stocks?

No stock screening method is foolproof -- finding the right investment is as much of an art as it is a science. However, every good investor should maintain a toolkit of screening techniques as they search for value. We are like detectives on the hunt for the perfect clue. So get your magnifying glasses out, because we are on the case.

Step 1: Find a stock worth trailing
OK, let's start by identifying an "undercover" stock that has recently beaten the pants off the market, while maintaining solid growth prospects. For that, we turn to our trusty Motley Fool CAPS screener to pinpoint stocks meeting the following criteria:

• Market caps between $250 million and $2 billion.
• Returns greater than 10% over the past 12 months.
• Five-star ratings (the highest possible) from CAPS.

Here are a few names from that screen:

Source: Motley Fool CAPS.

The result? Some intriguing stocks worth exploring. Take, for instance, J&J Snack Food. Despite the market turmoil, the simple small cap has increased by 24% over the last year while still boasting a five-star CAPS rating. This maker of branded snack food has quietly delivered an annual compounded rate of return of about 12% over the past 10 years.

Now, let's see who's been smart (or lucky) enough to own this small wonder.

Step 2: See who they pal around with
If we look up "JJSF" in Yahoo! Finance, a quick click on "Major Holders" will display the institutional and mutual funds that have significant, reportable levels of ownership. A scan of J&J Snack Food shareholders reveals some interesting names with solid investment street cred: Neuberger Berman, Royce & Associates, and Loomis, Sayles.

Now that we've found a warm trail, let's see where it leads. Royce & Associates is a small-cap investing legend that's definitely worth following.

J&J Snack Foods is held by at least one of its funds -- the Royce Total Return (RYTRX). Thanks to mutual fund regulations, we have all the information we could possibly want to know about the fund's portfolio.

Step 3: Rummage through their portfolio
A visit to Royce's website allows us to quickly glean its top five positions:

Sources: Royce Funds, Motley Fool CAPS. Holdings as of quarter-end 12/31/08.

Among the top holdings we find such unique companies as Ritchie Brothers Auctioneers. This crew just happens to be the world's largest industrial auctioneer, selling industrial equipment to the construction, transportation, mining, petroleum, and agricultural industries, among others. Whether we find ourselves in a commodity boom or bust, it seems like these auctioneers are nicely positioned in the middle of a whole lot of big-ticket transactions.

Step 4: Rinse, repeat, and keep digging as necessary
Fun, right? You can repeat this process continually and come up with an ever-expanding pool of both stocks and mutual funds that deserve further scrubbing. Heed Peter Lynch's sage advice, "The person who turns over the most rocks wins the game."

Need a partner in crime?
Whether you're trying to locate the best mutual fund or just trying to skim some high-quality portfolios for the best picks, investment success starts with one thing: a deep desire to find the needles in the haystacks, regardless of the obstacles.

That's the kind of ethic our team at Motley Fool Champion Funds brings to the job every day. So if you need help, or would simply like to snoop through our entire list of recommended funds, click here to join the service free for 30 days. Some of the coming year's best performers are most likely hiding out in plain view in one of our top-rated funds.

Andy Louis-Charles , a deep-value investor, does not own shares of any company mentioned. AllianceBernstein is a Motley Fool Income Investor pick. Quality Systems is a Motley Fool Stock Advisor recommendation. The Motley Fool is investors writing for investors.