We investors are an oddball bunch. With a universe of more than 9,000 stocks to choose from, we spend hours and hours scouring them trying to find the one that will be the next big breakout hit. The one that will double, triple, quadruple in value over time. Maybe even increase by more than 10 times! The fabled Peter Lynch 10-bagger (cue in trumpets and angels singing "Hallelujah!").
So we winnow and narrow our selections. We comb through reams of financial statements. We wear out the batteries on three calculators figuring out return on equity, net profit margin, and the worst calculation ever devised, return on invested capital. Then we perform our discounted cash flow analysis. Finally, when we've got our winner (or so we hope), we plunk down our hard-earned cash hoping it's the next home run stock. As I said, investors are a strange lot. We continue to reinvent the wheel every time. Think of it as wasted effort.
The secret to market-beating returns
Psst ! Wanna know the secret to finding the next home run stock?
You already own it.
Yep. That's right, it's already in your portfolio. You have already chosen some of your best ideas to invest in. You've done the winnowing and narrowing. Your hairline already resembles Tom Gardner's, the co-founder of The Motley Fool. So why go through all that hassle again?
Warren Buffett was fond of saying investors had a lifetime investment punch card with only 20 punches on it so we better make the best use of them. Chances are, your portfolio's punch card already has one or two or three companies on it that represent some of your best thinking. Why go through all the trouble again of trying to find something new when you already know the story so well with what you own?
Indeed, since we're on the prowl for finding a Lynchian 10-bagger, we might do well to heed the advice he gave in his best-seller Beating the Street:
"The best stock to buy may be the one you already own."
If you're still doubtful that a stock that's already up 30%, 40%, or 100% can't represent a good investment for you, think again.
Tom Gardner has created a unique service in Hidden Gems, his small-cap stock newsletter. Every month, he and a guest analyst unveil two companies with the greatest growth potential for the next three to five years and track them real-time with lively give-and-take on dedicated discussion boards. Over the service's 21 months, Tom's recommendations are beating the market by an eye-popping 25 percentage points! Yet to achieve those amazing results, he has revisited some of his best ideas.
The magic of re-upping
In July 2004, Tom recommended Buffalo Wild Wings
"B-Dubs," as it's affectionately called, has hundreds of restaurants in its chain, primarily in and around Ohio, but it's starting to make its national presence felt by expanding into New York, Florida, Texas, and elsewhere. And in just one month after Tom recommended it, the stock had jumped 15%. Not bad for a month, but we're concerned with our companies' performance over the long term, and the stock could just as easily have been down. Still, it was a nice gain for investors.
Well, defying logic and conventional wisdom, Tom recommended Buffalo Wild Wings again in the very next issue! That's just not done in investing newsletters. Everyone else churns out "new ideas" every month. But what's been Tom's result? Since the original recommendation, B-Dubs is up almost 50% compared to the market's 2.5% increase. If you bought the stock again on Tom's re-recommendation the next month, you'd be up an additional 32% compared with the S&P 500's 8% rise!
Maybe you're thinking that was a fluke. Well, check this out: In March of this year, Tom recommended Buffalo Wild Wings an incredible third time! He noted that not only was the company increasing sales year over year but also profits were growing, cash in the bank was on the rise, and the chain still had no long-term debt. Already the stock is up more than 8%, far distancing itself from the general market malaise. Yes, the S&P 500 is down more than 1% over the same time period.
With just one stock and three recommendations, Tom Gardner is whomping the market by an average of 27%. Which is what investors should remember: It's the quality of the stocks you're selecting, not necessarily the quantity.
Want a more contemporary example? Consider the remarkable story of Wal-Mart. On Feb. 26, 1985, the discount retailer was selling at a split-adjusted price of $0.83, already a multibagger in its own right (by the way, Wal-Mart never actually traded for $0.83, but that's what stock splits will do for you). Ten years later, it closed at $10.79, a 1,200% increase. And as of last Friday's close, it was trading at $48.57, yet another 350% increase and 5,700% overall!
While not every investment will be the next Wal-Mart -- in reality, few companies can do that well -- the moral of the story is you needn't continuously go out and find new investment ideas to achieve market-beating returns. Some of your old ideas can still represent your best growth possibilities. There's no need to reinvent the wheel.
If you'd like to check out the companies that Tom Gardner thinks are the multibaggers of tomorrow, Hidden Gems offers a 30-day free trial. Then these small caps can soon become some of your favorite ideas that you can invest in again and again.
This article was originally published on March 4, 2005. It has been updated.