Hey, what ever happened to that blindfolded chimp with the darts? You know, the little fellow with the stock table and blind daggers that 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? Put another way: If the billionaire boys' club can't hack it -- with all its 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 research. Certainly not if you ignore Wall Street research. Though counterintuitive, this last distinction is one I confirmed while working daily with Wall Street's institutional "buy side."
Ironic, huh? Now for the really good news ...
You
can beat the market
I met Motley Fool co-founder Tom Gardner when he and his brother David were launching Motley Fool Stock Advisor, their first newsletter in nearly a decade. I'll admit I was skeptical. Should this guy really be charging people 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 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 cannot beat the market picking individual stocks.
I'd seen too many try people and fail -- folks who were every bit as smart as I was -- rotating into and out of the same old stocks. Buying Sun Microsystems (NASDAQ:SUNW) and dumping Motorola (NYSE:MOT) in tech. Swapping ExxonMobil (NYSE:XOM) for Apache (NYSE:APA) in the oil patch (stocks they'd have done well to hold).
By constantly rounding up and turning loose the usual suspects, they sealed their fates. Most made money in 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 that investors (we) paid them.
There is a 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.
Yes, 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 in November 2003, 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 200%, guess who's sniffing around? Wall Street.
I know better than to draw conclusions from small samples. And not all of Tom's picks are three- or even two-baggers. Still, a full 37 of the 50 stocks recommended in Hidden Gems over the past two years are in the money. And as of July 19, 2005, they are up 36.1% on average. Compare that with about 10.7% for the Standard & Poor's 500.
Can you honestly beat the market?
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 stocks that were followed on Main Street long before Wall Street. Some of his biggest winners weren't all that common even on Main. The point being, companies that can reasonably rise five, 10, or even 20 times or more in value are (1) small but growing, (2) well-run, and (3) operate in great industries. To which I'd add, they are (4) run by founders with large personal stakes in the business.
What you can do now
Can I guarantee that you can become a great stock picker? No. But I can be pretty sure you don't want to be relying on Wall Street research. I mean it. You can make money owning the "most widely helds," whether your flavor is Intel (NASDAQ:INTC) or Pfizer (NYSE:PFE). But not so by jumping in and out -- especially on Wall Street upgrades and downgrades.
Most important, you don't want to be shuffling around the day's most actives, or even buying this week's Giga-Tronics (NASDAQ:GIGA) -- especially if you heard the name for just the first time yesterday. As much as I knock the market pros, you don't want to be taking the other side of their trades.
In a choppy market like this, I know of only one way to make real money with stocks. That is to buy where Wall Street isn't looking and hold on for the ride. If you want to learn more about this approach to finding undercovered and undervalued stocks, Tom Gardner 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. Paul does not own shares of any company mentioned in this article. Pfizer is a Motley Fool Inside Value recommendation. The Motley Fool isinvestors writing for investors.
