Homegrown Profits

One of the hardest things about investing in small-cap stocks is finding new ideas. There's typically less information available, less analyst coverage, and more uncertainty than with blue chips. Sounds like fun, right? But, hey, the market's 10 best stocks of the past decade all fit this profile.

So where can you begin to look for companies like these?

Take a look around town.

Stand in the place where you live
In Cincinnati, it's hard to watch the local news without hearing something about Procter & Gamble (NYSE:PG). P&G's omnipresence in the city is only natural -- the company was founded there in 1837 and remains the city's fourth-largest employer. Because of this, every whisper of downsizing, expansion, and employee morale finds its way around the city. A similar scenario exists in Houston with Halliburton (NYSE:HAL).

Unfortunately, professional analysts thoroughly cover large-cap companies like these. P&G and Halliburton, for example, have some 20 analysts following their stocks at all times. This leaves little room for a local investor to profit from neighborhood knowledge.

Local knowledge can, however, make a difference with small caps.

Your friendly neighborhood small cap
A good starting point for finding small caps may be your city's newspaper. Most will include a list of companies that have headquarters or major operations in the area. The Cincinnati Enquirer, for instance, publishes the Enquirer 80 index -- a sampling of publicly traded companies with relevance in the Greater Cincinnati region. Included in this list are:

Now, just because a company is local, that doesn't necessarily make it a buy. However, a list like the Enquirer 80 may provide you with some companies worthy of further research -- you know, the boring but important quantitative stuff.

Consider the case of Alderwoods, a Motley FoolHidden Gems pick, which recently agreed to be bought out by rival Service Corp. International (NYSE:SCI) for $20 per share. In the first 14 months following its 2002 offering, the stock lost 79% of its value -- probably sending any analyst thinking of covering it running for the hills. Indeed, things looked pretty grim.

This is where a Cincinnatian could have capitalized. In March 2004, a reader of The Cincinnati Enquirer's business section would have noticed the headline "Alderwoods Report Shows a Turnaround," a recap of some very positive developments at the company. Upon further research, a curious investor would have seen a company with accelerating growth, increasing free cash flow, and a strong management team focused on reducing the company's heavy debt burden following its emergence from bankruptcy.

The stock was then trading around $10 a share.

The Foolish bottom line
Interestingly enough, our Hidden Gems team learned about Alderwoods' turnaround from a member of our Fool community back in 2003. Our analyst saw its improving financials and FCF growth, and he recommended it to our readers when it was trading around $7. The 173% return has been nice.

So if you're looking for new small-cap stock ideas, start with your local newspaper. Or if you want a cheat sheet of our recommendations at Hidden Gems, give our service a try free for 30 days. The team offers two new ideas each month and thoroughly explains the drivers that make them worth holding for the long run. Follow the link for more information.

A Cincinnati native, Todd Wenning remained a loyal Cincinnati Bengals fan throughout the 1990s and scoffs at fair-weather fans everywhere. He does not own shares in any of the companies mentioned. The Fool's disclosure policy puts Hammurabi's Code to shame.