Over the past two years, stocks recommended by the Motley Fool Hidden Gems small-cap investing newsletter have outperformed the S&P 500 stock market average by 20 percentage points.

Humility trumps hubris
That's a boast. Grounded in facts, certainly -- because we have the numbers to back it up. But there's no denying that when we tell you how well our newsletter's recommendations have performed, we're definitely tooting our own horn. So on the morn of our latest edition (more on that below), let's reflect on how Hidden Gems became so successful. Because we didn't get here on our own.

Study the masters
The secret to Hidden Gems' success is simple: We stand on the shoulders of giants. The fact that we're beating the pants off the market averages owes at least as much to our study of the world's great investors as it does to the stock-picking wizardry of Fool co-founder Tom Gardner and his merry team of hunters. Over the years, we've read -- and we've recommended to our members -- all the standard investing classics:

  • Ben Graham's TheIntelligent Investor
  • Peter Lynch's One Up on Wall Street
  • Philip Fisher's Common Stocks and Uncommon Profits

But our competition has read all of these, too. They know to "buy under book value," "buy what you know," and "never sell." And so, to beat them, we go further. In our continuing quest to help individual investors become wealthy individual investors, we've also researched the investing strategies of:

  • John Neff, the manager who took over Windsor Fund at age 32 and revived a broken franchise, leading it to 32 market-trouncing years.
  • Shelby Davis, the New York insurance analyst who grew a $50,000 account into a nearly $900 million fortune over five decades of investing in good times and bad.
  • Hetty Green, the 19th-century investing maven who over a lifetime of saving and investing in stocks built a fortune valued at $20 billion in today's dollars.

Neff, Davis, and Green, as well as dozens of other very successful but poorly publicized personages, are the unsung heroes of the individual investor. These are the teachers we study. These are the inspiration and the source of our success.

Through continual study of these investing giants (both the famous and the not-so-much), we've distilled the wisdom of the masters down to a few guidelines that, in spite of our small size and wingtip-less background, have enabled Hidden Gems to crush the Street for two years running (and counting). Today, we're sharing them with you.

Must have cash
Debt makes investors fret. When interest rates rise, so too does the cost of servicing debts -- sapping strength from profits. If you own shares of AK Steel (NYSE:AKS), which carries four times as much debt as it has cash on hand, beware the heavy hand of Chairman Greenspan. Conversely, shareholders of rival steelmaker Nucor (NYSE:NUE), whose treasury brims with cash, can rest a bit easier.

Must have real profits
Heed the words of Third Avenue Value fund manager Martin Whitman: "What the numbers mean is more important than what the numbers are." In this sense, "what the numbers are" is GAAP profits -- and Enron taught us how truly malleable such numbers can be. The savvy value investor prefers companies that generate cold, hard cash profits -- free cash flow. While pleased to see La-Z-Boy (NYSE:LZB) report $3.2 million in profits earlier this week, he'd have focused more (and even more happily) on the $13.1 million in cash appearing on the company's cash flow statement.

Must have owner-operators
You tell me: Would shareholders of Tyco (NYSE:TYC) be better off today if Dennis Kozlowski and his gang had owned more than a fraction of 1% of the company they were robbing? When a company's managers own a stake in the business -- what we call "insider ownership" -- there is incentive to create lasting value for shareholders. Owner-operators of a business are natural allies of outside shareholders; when the business prospers, everybody wins. That's why, when researching potential Hidden Gems, we prefer companies where management owns at least 10% of the business.

Must have large font
The most recent 10-K filing for megabank JPMorgan Chase (NYSE:JPM) ran to 145 pages. Citigroup's (NYSE:C) was more than 150 pages. Meanwhile, little Mine Safety, a company that has nearly tripled in two years on the Hidden Gems roster, offers its investors a mere 50 pages of reading material. Heck, with all that space, the company could go wild and print its financials in easy-to-read 12-point font -- investors would still have less paper to plow through. More important than the font size, though, is the fact that small companies like Mine Safety are transparent. Fewer pages mean fewer places to hide inconvenient facts. It means we're less likely to be surprised, and less likely to invest in something we do not understand.

Must (not) have sex appeal
And while we're on the subject of things we don't understand -- satellite radio, anyone? How about nano-stem-fuel cells? Companies like WorldSpace (NASDAQ:WRSP), Altair Nanotechnologies, ViaCell, and Ballard have two things in common: they're all "hot" stocks and they're all losing money hand over fist. At Hidden Gems, we leave the fast money to the day traders and stick to our knitting -- finding great, profitable, unknown companies that make for great, profitable, who-cares-if-you-know-about-it-it-made-me-rich investments.

Speaking of which, I need to wrap this column up, because in just a few hours, Hidden Gems will release its September issue. At 12:00 noon EST, two new cash-rich, profitable, owner-run, easy-to-understand, and boring-as-can-be companies will break upon the investing scene. Would you like to be among the first to see who they are? You can. Just click right here and sign up for 30 free days of access to Hidden Gems, today's picks included.

(And by the way, we have a firm policy around here: If you aren't thrilled with the service, you may cancel at any time -- no strings attached. So have no fear, sign up right here.)

Fool contributor Rich Smith does not own shares of any company named above. If he did, we'd make him tell you about it. La-Z-Boy is a Motley Fool Income Investor recommendation.