Buy This Stock Before Your Neighbor Does

"The overwhelming majority of people are comfortable with consensus, but successful investors tend to have a contrarian bent." -- Seth Klarman, founder of the Baupost Investing Group

I learned early on that I come from contrarian stock. At 10 years old, I asked my dad why he didn't buy a nice new car like the other dads in the neighborhood -- after all, he worked hard days and weekends and could have afforded it. He looked at me and said, "Son, cars are depreciating assets."

Despite examples to the contrary, however, we as humans are hardwired not only to care what other people think, but to follow the herd in almost every scenario.

Especially your neighbors
Consider the following experiment conducted by Robert Cialdini, professor of both psychology and marketing.

He wanted to find out what would persuade people to conserve energy, so he put leaflets in people's doorways with different messages. One group received leaflets with facts about how energy conservation helps the environment, another group received information on how much money they could save, and one group received leaflets that read, "The majority of your neighbors are conserving energy." One control group received no leaflets. Later, they checked the gas meters to see who had, in fact, changed their energy consumption.

I'm sure you see where I'm going with this -- the most effective leaflet was the one telling people that their neighbors were conserving energy. As Cialdini says, people will almost always do things they know or believe other people are doing. Think about how many times you've stopped and looked up at the sky just because other people were doing it.

That's why bubbles are so devastating -- we tend to get caught up in the excitement, buying shares of NVIDIA (NASDAQ:NVDA) and Cisco Systems (NASDAQ:CSCO) when they traded close to record highs, right before they plunged by more than 80%. We couldn't help it -- everyone else was doing it.

Far from the madding crowd
There are some great reasons to practice going against the grain -- especially when it comes to investing.

Following stocks that everyone else is following hardly gives you much of an advantage -- you're forced to compete against not only thousands of other investors, but hundreds of scrupulous Wall Street analysts.

On the other hand, tracking stocks that are typically ignored -- i.e., small-cap stocks -- allows you to find mispricing situations, and once you can identify a great company that's undervalued -- well, you've just hit a gold mine.

For example, I bet most of your neighbors haven't heard of Innophos Holdings (NASDAQ:IPHS). This small-cap company plays in the specialty phosphates market and provides chemicals that show up in almost every aspect of your daily life. From electrolytes in sports drinks to leavening agents in baked goods, Innophos' products are also used in pharmaceuticals, asphalt, and detergents. Because of its 40% market share and its straightforward business, Innophos caught the eye (and the recommendation) of our Motley Fool Hidden Gems analysts.

Over the past three years, it's averaged a 61% return on equity, and over the same time period, it's increased by revenues by an annualized rate of 10% and EBIT by over 50%. In the past year alone, it's experienced a whopping 57% gain.

You simply can't find that type of growth from companies your neighbors have already heard of -- blue-chip stocks like AT&T (NYSE:T) or Procter & Gamble (NYSE:PG). Those companies are just too big to grow that fast again.

Keep it in the family
To find the stock champion of the next 10 years, you'll need to avoid the herd -- and look where your neighbors aren't. That means seeking out small-cap stocks that are being ignored, and then finding the ones that have excellent growth, that return money to shareholders, and that are trading cheaply.

For example, here are some lesser-known small caps that have some of the qualities needed to see some enormous gains:

*Data taken from Capital IQ, a division of Standard & Poor's. TTM = trailing 12 months.

I'll be honest -- not all small-cap stocks are going to be a perfect fit. But if you have the guts to pick the less popular stocks, your portfolio will surely reap some tremendous benefits.

Those are the kinds of stocks we buy for our Hidden Gems real-money portfolio -- and our picks are beating the market. If you're interested in seeing the stocks our analysts are recommending, we're offering 50% off the list price through Sunday -- and you get a free copy of Stocks 2010, our flagship report, along with it. Just click here to get started.

Already a Hidden Gems member? Log in at the top of this page.

This article was originally published Oct. 16, 2009. It has been updated.

Fool contributor Jordan DiPietro owns no shares mentioned above. NVIDIA is a Motley Fool Stock Advisorselection. Procter & Gamble is an Income Investor recommendation. The Fool owns shares of Innophos Holdings and Procter & Gamble and has a disclosure policy.