Stop me if you've heard this one. The one stock you must buy is ... the next Dish Network
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, Dish, Infosys, and Schwab are some of the stock market's great success stories. These companies have earned early investors mind-boggling returns since they were small companies.
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 Dish, Infosys, or Schwab before they were big names?
That's not to say that one stock will be a tech superstar or an emerging-markets play. Rather, Dish, Infosys, and Schwab all share a set of remarkable traits that characterized them when their amazing runs began. All were:
- Small.
- Led by dedicated founders.
- 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 Heelys
Were they small? Yes. A year ago, Heelys was capitalized at $116 million and Crocs at $776 million.
Were they led by dedicated founders? Sort of. Neither company's founder continued to lead the company, but both had founders who remained involved. Roger Adams, for example, founded Heelys in 2000. He was serving as its director of research and development. And Duke Hanson, who co-founded Crocs, was a VP.
Were they fiscally conservative? Both companies had success with their products, with booming sales and income and solid balance sheets in the past, but both had also seen accounts receivable and inventories balloon -- lending credence to the notion that both company's products are nothing more than fads.
Did they have wide market opportunities? It was always a little cloudy here. While both companies have products that have received rave reviews, any investing thesis depends on being able to predict whether the brands are fads or if they can expand and have staying power. The recent decline in both stocks -- Crocs is down 75% over the past year and Heelys 39% -- is a warning about what can happen when a market dries up.
The Foolish final word
I'm not here to be negative about either Heelys or Crocs. Both have positive traits and could rebound. I don't, however, think either one has the collection of traits that made companies such as Dish Network, Infosys, and Schwab such incredible long-term 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 dedicated founders.
- 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, click here to join Hidden Gems free for 30 days. There is no obligation to subscribe.
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This article was originally published Oct. 19, 2006. It has been updated.
Tim Hanson does not own shares of any company mentioned. Schwab is a Motley Fool Stock Advisor recommendation. The Fool's disclosure policy assures you that no stocks were harmed in the penning of this article.
