The 10 best-performing stocks of the last decade were obscure, ignored, and small. But what about the top 25? The top 50? The top 100?

It turns out that most of the stock market's greatest performers of the past 10 years were also obscure, ignored, and small.

Small stocks for big returns
There were 325 stocks that could have earned you greater than 20% annualized returns over the past 10 years -- turning a $10,000 initial investment into more than $60,000. Of those 325 stocks, 296 of them were small caps. That's more than 90%. While the companies run the gamut from trendy retailer Urban Outfitters (NASDAQ:URBN) to food-service equipment manufacturer Middleby (NASDAQ:MIDD), the common thread is size.

Ten years ago, Urban Outfitters was a $260 million company. Today, it's worth more than $4 billion. Middleby grew from $90 million to $750 million.

And Middleby, for one, is still growing. The company dominates its niche and has almost every trait investors should look for in a small cap: superior leadership, a clear competitive advantage, and simply mind-boggling returns on equity (approaching 40% over the trailing 12 months). As a three-time recommendation in our Motley Fool Hidden Gems newsletter, it has returned 44%, 101%, and 415% for our members.

Big stocks for smaller returns
There were only 29 mid- or large-cap companies that would have given you the same growth, and they're the cream of the crop: Electronic Arts (NASDAQ:ERTS), UnitedHealth (NYSE:UNH), and Valero (NYSE:VLO), to name three. And while the returns have been incredible from these three companies -- all of which benefited from greater consumer spending on electronics, health, and energy-- they just don't stack up against the small guys.

That's because it's difficult for larger companies to generate the same kind of growth as small caps. While Middleby grew from $90 million to $750 million, Electronic Arts grew from a $2.3 billion valuation to $15 billion. While Electronic Arts added more value in absolute terms, the story changes when it comes to percentages. Middleby increased more than 700% to Electronic Arts' 500%. Now compare that to much larger companies such as General Electric (NYSE:GE) or Time Warner (NYSE:TWX). Those two companies have added $200 billion and $60 billion of value, respectively, over the past 10 years. But those increases have resulted in just 150% and 450% gains for investors. That's a consequence of the Law of Large Numbers, and it's a simple and crucial point in investing.

The Foolish bottom line
Small caps are one area of the market where the individual investor has the opportunity to earn phenomenal returns, but there are also pitfalls. For every one of the 296 small caps that could have earned you greater than 20% annualized returns over the past 10 years, there were quite a few more that didn't make it. Small-cap stocks tend to carry considerably more risk than large caps, so investors must consider their investments very carefully.

That's why we advocate a diversified portfolio of select small caps for Hidden Gems subscribers. By focusing on factors like superior management and a strong balance sheet and enjoying the benefits of diversification, our small-cap recommendations have outperformed the market by 25 percentage points since we started.

Every investor should have at least some smart exposure to small caps because the historical profits are just too good to pass up. If you'd like some help getting started in this incredible area of the market, click here to join our community. If you're not completely happy with our research and updates, we'll gladly refund your subscription.

This article was originally published on Feb. 6, 2006. It has been updated.

Tim Hanson owns shares of Valero and Time Warner. Electronic Arts, UnitedHealth, and Time Warner are Motley Fool Stock Advisor recommendations. No Fool is too cool for disclosure ... and Tim's pretty darn cool.