"Over the years, small-cap stocks crush their large- and mid-cap peers."
That's how I planned to open today. Shoot, I'd be making my case by now -- dropping names like Nagel and Quigley among 70 years' worth of data from Ibbotson.
But you're no dummy
And by ... now! my inbox would be full. "Your results are skewed by abnormal years," you'd be shouting, or "What about survivorship bias?" And you would be right. You would have found the fatal flaw in all historical data: The future is not the past.
So forget the big numbers
Fortunately, you don't need Excel to prove that tomorrow's big winners are small caps today. You just need these three clues. After all, it's a pretty safe bet that tomorrow's Amazon.com (NASDAQ:AMZN) is ...
- Run by entrepreneurial zealots with ownership stakes.
- Free of convoluted relationships with investment banks.
- Able to grow its sales and cash flow exponentially.
And because it's off Wall Street's radar (for now), there will be pent-up demand when those revenues rocket and analysts catch on.
Get in on the ground floor
My father once told me to "be your own boss and die rich." He had a point. If we were smart, we took stock in Ameritrade (NASDAQ:AMTD) and whooped it up with Yahoo! (NASDAQ:YHOO), but we didn't do nearly so well as their earliest investors, Joe Ricketts and Terry Semel.
Of course, this is nothing new: The nearer your grandfather got to Henry, the sweeter his investment in Ford Motor. Old Herbert Henry Dow became the richest chemist in the world when Dow Chemical (NYSE:DOW) took over the world.
Sadly, few of us build empires or even place seed money or venture capital. But we can get in early. We just need to be patient and pick our spots. Or take a cue from Tom Gardner's Motley Fool Hidden Gems method and seek out companies with market caps below $2 billion offering:
- Solid management with big stakes
- Great, sustainable businesses
- Dominant positions in niche markets
- Sterling balance sheets
- Strong free cash flow
Just remember those five keys
In the '90s, they led folks straight to AdobeSystems (NASDAQ:ADBE) and Applied Materials (NASDAQ:AMAT) -- and to absolutely ridiculous gains. Just as decades earlier they brought folks to IBM (NYSE:IBM). In just the past two years, they have led the Hidden Gems gang to a half-dozen stocks that doubled in value or more.
(In the spirit of full disclosure, as a group the Hidden Gems picks are up an average of 32.8%. For context, that's compared with 7.8% for the S&P 500.)
I bring this up now because this choppy summer market could be your second chance. Market malaise -- even weakness -- can be seasonal and indiscriminate. When it hits, you want to have a wish list of great small companies to buy on coming dips. I have mine right here.
If you need some help putting your list together, Tom Gardner is offering a 30-day free trial to Hidden Gems. It could be the thing for you. Of course, there is no obligation or pressure to subscribe. Click here to learn more.
This article was originally published on May 10, 2005. It has been updated.
Paul Elliott no longer owns (sadly) any of the stocks mentioned here. Amazon.com is a Motley Fool Stock Advisor recommendation. Dow Chemical is a Motley Fool Income Investor recommendation. The Motley Fool has adisclosure policy.
