Is it me, or has it been a while since we trotted out that blindfolded chimp with the darts? You know, the little guy 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? I mean, if the billionaire boys' club can't hack it -- with all their computers and contacts -- what chance do we have of thumping that pesky chimp?
Here's what you can do with your Wall Street research
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 most money managers can't seem to manage (at least once 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 portfolio. Not if you use independent sources. Certainly not if you ignore Wall Street research. That sounds funny, but it's a fact I confirmed myself while working with Wall Street's institutional "buy side."
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 their Motley Fool Stock Advisor newsletter. I'll admit I was skeptical. I mean, really, should this guy be charging subscribers for his research ... can a Shakespeare nut in a Fool cap really pick stocks?
Fat chance. I'd spent years peddling data and "analytics" to Wall Street. And it was my experience 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 fail -- folks who were every bit as smart as I was -- rotating into and out of the same old stocks. Buying Microsoft (NASDAQ:MSFT) and selling Intel (NASDAQ:INTC) in tech. Gobbling up or spitting out Gap (NYSE:GPS) in retail, and washing it down with a big block of Coca-Cola (NYSE:KO).
By constantly rounding up and turning loose the usual suspects, they sealed their fates. Most made their clients 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 and bonuses investors (we) paid them.
At last, a "secret" to picking winners
By the time Tom Gardner started his small-cap newsletter service, Motley Fool Hidden Gems, I was coming around. Already, Tom was consistently picking stocks that were outperforming the market. And he was doing it using good old-fashioned legwork and bottom-up fundamental analysis.
Granted, his criteria 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 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.
And, yes, Tom Gardner and his team screen hundreds of stocks each month, but something set this 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 recommended the stock to his Hidden Gems subcribers, the business and financials looked great. Granted, 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 -- didn't either. Now that the stock's up more than 350%, guess who's sniffing around?
Wall Street. 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, as of Dec. 20, 2005, they're up 32.7%. Compare that with about 11.7% if you'd bought the S&P 500 instead.
What Tom Gardner 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) really 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 keep you posted.
Until then, I opened with Peter Lynch -- and the chimp -- for a reason. Unlike your typical fund manager, 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!
That's how Lynch made a killing on stocks like Dell (NASDAQ:DELL) and Home Depot (NYSE:HD) long before they were followed on Wall Street. Some of his biggest winners weren't all that common even on Main Street.
Lynch knew that 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 profitable industries. To which I'd add, they (4) are run by founders with large personal stakes in the business.
Yes, you can find stocks like these
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. And you don't want to be shuffling around the week's most actives, or buying yesterday'sMicromuse (NASDAQ:MUSE). Most importantly -- 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 one, there's only way I know 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 Hidden Gems approach to finding undercovered and undervalued stocks, you can take 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 (you can see all the picks with your free trial). He owns none of the stocks mentioned. Coca-Cola, Microsoft, and Home Depot are Motley Fool Inside Value recommendations. Gap and Dell are Motley Fool Stock Advisor picks. The Motley Fool isinvestors writing for investors.
