Stop me if you've heard this one. The one stock you must buy is ... the next Apple
That's a pitch I'm sure you've heard some semblance of at cocktail parties, golf outings, weddings, and, of course, on the Internet.
And it's a pretty appealing pitch. After all, Apple, Amazon, eBay, and Garmin are some of the stock market's great success stories. These companies have earned early investors mind-boggling returns over very short periods of time.
The secrets of success
So the question is: Does that one stock you must buy exist? Of course it does. But can you find it? That's a different matter.
Here, however, is a litmus test to gauge every stock tip you come across. Simply ask: Does this company bear any resemblance at all to Apple, Amazon, eBay, or Garmin before they were big names?
That's not to say that one stock will be a tech superstar. Rather, Apple, Amazon, eBay, and Garmin all share a set of remarkable traits that characterized them when their amazing runs began. All were:
- Small.
- Led by a dedicated founder(s).
- Fiscally conservative.
- Profiting from a wide market opportunity.
If the next stock that's pitched to you doesn't possess these traits, then you're probably better off passing.
A case study
Consider, for example, the cases of Advanced Micro Devices
Are they small? No. AMD and Altera are both capitalized at approximately $8 billion.
Are they led by dedicated founders? No. Both Hector Ruiz and John Daane came from other companies. Neither owns a significant percentage of his company's shares.
Are they fiscally conservative? It would seem so. Both companies have strong balance sheets, though AMD has made huge capital expenditures recently in order to compete with archrival Intel.
Do they have wide market opportunities? It gets a little cloudy here. While both companies have opportunities to grab greater market share, they both operate in extremely competitive industries. Whatever gains they make will be hard-fought and may not last.
The Foolish final word
I'm not here to be negative about either AMD or Altera. Both could make for good investments going forward. I don't, however, think either one has the core traits that made companies like Apple, Amazon, eBay, and Garmin such incredible investments and that we look for at our Motley Fool Hidden Gems small-cap investing service.
Again, we believe that tomorrow's big winners will start off:
- Small.
- Led by a dedicated founder(s).
- Fiscally conservative.
- Profiting from a wide market opportunity.
If you'd like to take a look at the companies we've found that meet the four criteria mentioned above and have put our service 35 percentage points ahead of the S&P 500 since 2003, click here to join Hidden Gems free for 30 days.
This article was originally published on Oct. 19, 2006. It has been updated.
Tim Hanson does not own shares of any company mentioned. Amazon, eBay, and Garmin are Stock Advisor recommendations. Intel is an Inside Value pick. The Fool's disclosure policy assures you that no stocks were harmed in the penning of this article.
