It's easy to look back at huge stock success stories of today and see why companies became so successful. For instance, EMC (NYSE:EMC) deftly navigated the budding computer-storage solutions market to become a dominant supplier in the mid-1990s. Investors who saw potential and put $10,000 in budding EMC at the start of the '90s would be sitting on a staggering $1.6 million today.
All successful corporations were at some point small, fledgling companies struggling against the giants of the time. EMC was only a $150 million company beating away at IBM's (NYSE:IBM) dominant position at the start of the booming '90s. Similarly, Yahoo! (NASDAQ:YHOO) had its share of stiff competition for online mind share from AOL and other early entrants into the Internet medium.
So just how do investors spot future winners that are small today but destined for greatness tomorrow?
Baby steps
For budding small-cap companies today, it is sometimes difficult to see how big they will become or what they will look like "when they grow up." But it is very important for an investor to consider this question -- how will this company grow 10 times larger? Or 100 times larger?
For instance, Warren Buffett could envision Coca-Cola (NYSE:KO) growing sales of syrup and cases of cola in underserved international markets back in 1988. At the time, many couldn't see how a $10 billion soft-drink maker could grow to be a company 10 times that size.
When studying our long list of potential investments to recommend for our Motley Fool Hidden Gems subscribers, there are three situations that make us sit up and take notice.
Today's three tips
First, we like to find a quality company that dominates a niche in an existing market. For instance, Whole Foods Market (NASDAQ:WFMI) was only a small, regional player before it started to move up and take customers from mainstream supermarkets. It dominated the natural-foods space from the beginning and leveraged its strength there to expand into the $7.5 billion company it is today.
Second, we like to find small organizations with strong leaders that have already proved their mettle. Poorly managed inventories or spiraling debt are not signs of a lean and well-run company. Positive cash flows, high insider ownership, and share buybacks or dividends, on the other hand, are.
Lastly, we also like to find small caps in largely untapped, emerging markets. Simply put, these companies are capable of astounding growth. Think of eBay (NASDAQ:EBAY) before everyone realized how popular the Internet would become as a place for commerce.
One free stock tip
Hidden Gems recommendation Blackboard (NASDAQ:BBBB) is a stock we really like. It's emerging as the dominant player in the field of educational software and applications. The $700 million company is consolidating its position and has plenty of opportunity in the massive education market in the years ahead.
The Foolish bottom line
Quality companies that own a corner of an emerging market are in an ideal position to make big returns. At Hidden Gems, we search out the most promising small companies to recommend for the next decade. You can preview Hidden Gems free for 30 days and see just which modest companies we think are destined for exceptional returns.
Yahoo!, eBay, and Whole Foods are Stock Advisor recommendations. Coca-Cola is an Inside Value recommendation.
Fool contributor Dave Mock is still not quite sure what he wants to be when he grows up. The longtime Fool is also the author of The Qualcomm Equation . He owns shares of Coca-Cola. The Motley Fool has a disclosure policy .
