Is it me, or has it been a while since we trotted out that blindfolded chimp with the darts? You know, the little fellow with the blind daggers and stock table who routinely outwits the typical Wall Street money manager. Cute story. But is it true?
And if it is true, why? Or should I say how? And where does this leave a bunch of Joe and Josephine Odd Lots like us? Holy cow, if the billionaire boys' club can't hack it -- with all their computers and contacts -- what chance do we have of beating that pesky chimp?
The sad and happy truth
Now, assuming he actually hits a stock with every dart, it's all pretty much true. The chimp's unbiased approach (hence, I suppose, the blindfold) keeps him at the market average -- no better, no worse -- which is something many money managers can't seem to manage (at least after you subtract their fees).
That's the bad news. The good news is that it really doesn't matter. Not if you're managing your own stock portfolio. Not if you use independent sources. Certainly not if you ignore Wall Street research. Though counterintuitive, this last distinction is one I confirmed myself while working daily with Wall Street's institutional "buy side."
Ironic, huh? Now for the really good news...
can beat the market
I met Motley Fool co-founder Tom Gardner when he, with his brother David, was launching Motley Fool Stock Advisor, their first newsletter in nearly a decade. I'll admit I was skeptical. Should this guy really be charging subscribers for his research? I mean, could a Shakespeare nut in a Fool cap really pick stocks?
Fat chance. I'd spent years working for a ubiquitous peddler of broker data and "analytics" to Wall Street. And here's the irony: It was this interaction with the sell-side analysts and buy-side money managers that convinced me that -- lacking real inside information -- you simply cannot beat the market picking individual stocks.
I'd seen too many try and fail -- folks who were every bit as smart as I was -- rotating into and out of the same old stocks. Buying Microsoft
By constantly rounding up and turning loose the usual suspects, they sealed their fates. Most made money in the boom years and got creamed in the bad. But they almost never beat the market -- few ever really outperformed. Certainly, not enough to justify the fees investors (we) paid them.
The secret to picking winners
By the time Tom started his new small-cap newsletter service, Motley Fool Hidden Gems, I was coming around. The performance results were admittedly green, but for Stock Advisor Tom was consistently picking stocks that were outperforming the market. And to my surprise, he was doing it using good old-fashioned legwork and bottom-up fundamental analysis.
Granted, many of the criteria he applied -- and that are still applied at Hidden Gems -- were no secret to Wall Street. They'd been passed down to us as finance majors and in books, from Benjamin Graham through Walter Schloss, Bill Miller, and Peter Lynch. They were the true masters, but we were all looking for:
- Solid management with significant stakes;
- Great, sustainable businesses;
- Dominant positions in niche markets;
- Sturdy (if not sterling) balance sheets; and
- Strong free cash flow.
It's true that Tom Gardner screens hundreds of stocks each month and has great instincts, but surely something set his performance apart from the market pros I'd known. Turns out it was two somethings: (1) Tom wasn't jumping into and out of stocks, sectors, or markets; and (2) I hadn't heard of most of the stocks he was recommending. Eureka!
Anatomy of a winner
Little Middleby makes ovens -- commercial ovens of all things. When Tom floated the idea and then formally recommended it in Hidden Gems last November, the business and financials looked great. But the markets are at least somewhat efficient, I thought; surely anybody could easily see what Tom and I saw.
But here's the catch. I ran the name on Multex and Bloomberg, even First Call. Nothing. The sell-side analysts didn't care, so the buy-side money managers -- the guys who really move the markets and who buy the sell-side research (gasp! too often with soft dollars) -- didn't either. Now that the stock's up more than 185%, guess who's sniffing around? Wall Street.
Much the same happened with FARO Technologies, which Tom tossed out the very next month. FARO makes state-of-the-art measurement systems used in a wide range of manufacturing. Another niche market -- again, no Wall Street coverage. FARO is up 118% since, but like most small-cap issues, it is volatile. In other words, the stock gives little guys like us lots of opportunities to buy.
I know better than to draw conclusions from a few examples. And not all of Tom's picks are three- or even two-baggers. Still, a full 34 of the 48 stocks recommended in Hidden Gems since inception are in the money. And taken together, they're up on average more than 32.5%. Compare that with about 8.8% for the Standard & Poor's 500.
What I can do for you
It takes a lot to convince a skeptic like me. But I'm sensing a trend. Mark Hulbert, who watches the newsletter industry like a hawk, offers evidence that some guys (and gals) can pick stocks. But this Hidden Gems deal I'm seeing with my own eyes. Whether it's up or down from here, I'll be watching. Rest assured, I'll keep you posted.
Until then, I opened with Peter Lynch -- and the chimp -- for a reason. Unlike your typical Wall Streeter, both throw their darts at any stock on the board. Market cap too small? No such thing. No Wall Street coverage? Bring it on. No convoluted relationship with big investment banks? All the better. Never heard of it? Bingo!
Lynch made a killing on a Dell
What you can do now
Can I guarantee you can become a great stock picker? No. But I can be pretty darn sure you don't want to be relying on Wall Street research. You don't want to be shuffling around the week's most actives, or even buying and selling this week's Internet Initiative Japan
In a choppy market, like this, there's only way to make real money with stocks. That is to buy where Wall Street isn't looking and go along for the ride. If you want to learn more about Tom Gardner's approach to finding undercovered and undervalued stocks, Tom is offering a special 30-day free trial. Click here to learn more.
This commentary was originally published on Nov. 10, 2004. It has been updated.
Fool writer Paul Elliott promises to keep you posted on Tom Gardner's progress at Motley Fool Hidden Gems . All picks and results are posted on the Hidden Gems website. He owns none of the stocks mentioned. Coca-Cola is a Motley Fool Inside Value recommendation. Gap and Dell are Motley Fool Stock Advisor recommendations. The Motley Fool isinvestors writing for investors.