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 the age of 10, 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 ConocoPhillips (NYSE: COP) in mid-2008 when it was trading close to record highs, right before it plunged by over 50%. Of course now, trading at a really reasonable seven times expected earnings and paying a generous 4% dividend, the stock actually looks quite attractive. But in 2008, we just couldn't help it -- everyone else was doing it, so we bought in, too!

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, many of your neighbors probably haven't heard of Dawson Geophysical (Nasdaq: DWSN), a small, $190 million company that provides seismic data to energy companies. However, as demand for oil services increases, so does the demand for Dawson's services -- and with a nascent recovery due in natural gas as well, this company stands to recover quite well along with the energy sector as a whole.

Because of its unique position in the industry, Dawson caught the eye (and recommendation) of our Motley Fool Hidden Gems analysts. Dawson has been able to increase revenues compounded annually over the last five years, and its balance sheet is crystal clear -- $49 million in cash and zero debt. In addition, Dawson has logged 10% annual gains over a decade where the market has actually been negative; our team just couldn't pass this opportunity up.

You simply can't find that type of growth from companies your neighbors have already heard of -- big name stocks like Telefonica (NYSE: TEF) or BP (NYSE: BP). Both companies have market caps over $85 billion, and they're being followed by over 30 analysts apiece. Not to say that they aren't great companies -- both have outperformed the market over the last 10 years -- but neither is expected to grow earnings above 10% over the next half decade. Telefonica operates primarily in Europe and Latin America where mobile penetration rates are high and growth is limited, and BP is being squeezed by thinning refinery margins and lower production. So if you're looking for high growth, then you've got to look toward the small cap brethren.

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.

Each of these companies is trading cheaply, has proven it can sustain top-line growth while returning money to shareholders, and best of all -- they're small, so there's plenty of room for growth!

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, just click here to get started.

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Jordan DiPietro owns shares of Telefonica. China Marine Food Group is a Motley Fool Global Gains pick. Dawson Geophysical is a Motley Fool Hidden Gems recommendation. The Fool owns shares of Dawson Geophysical. The Fool has a disclosure policy whose neighbors recently complained that it walks too loudly.