Stop me if you've heard this one. The one stock you must buy is ... the next EchoStar Communications
That's a pitch I'm sure you've heard some semblance of at cocktail parties, golf outings, and weddings, and, of course, on the Internet.
And it's a pretty appealing pitch. After all, EchoStar, Infosys, and Schwab are some of the stock market's great success stories. These companies have earned early investors mind-boggling returns over short and long 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 EchoStar, 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, EchoStar, 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
But were they small? Yes and no. Heelys was capitalized at almost $800 million, Crocs at more than $4 billion.
Were they led by dedicated founders? Neither company's founder was leading his respective company at the time, but both continued to be involved. Roger Adams, for example, founded Heelys in 2000. He's its director of research and development. And George Boedecker, who co-founded Crocs, was the largest shareholder -- though he did eventually resign from the board.
Were they fiscally conservative? While both companies looked like strong operators at the time given the recent success of their products, with booming sales and income and solid balance sheets, both were seeing accounts receivable rise sharply -- an indication that demand was declining.
Did they have wide market opportunities? It gets a little cloudy here. While both companies had products that had received rave reviews, any investing thesis depends on being able to predict whether the brands are fads or whether they can expand and have staying power. Both stocks have since been crushed as the fads faded and the companies could not achieve the expectations that were priced into their stocks.
The Foolish final word
I'm not here to be negative about either Heelys or Crocs. Both have positive traits and could make for good investments going forward. I don't, however, think either one has the collection of traits that made companies like EchoStar, Infosys, and Schwab 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 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, 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 owns no shares of any company mentioned. Schwab is a Stock Advisor recommendation. The Fool's disclosure policy assures you that no stocks were harmed in the penning of this article.
