'New Breed' Is Really Best in Show

This column was originally published on RealMoney on Sept. 26 at 10:28 a.m. EDT. It's being republished as a bonus for TheStreet.com readers.

Many investors adhere to the wisdom of buying shares in "best of breed" companies. But few if any acknowledge the inherent danger in following that strategy too closely.

Too often, best in breed is a reference to a company's past success rather than its future potential. My view is that, outside of savvy cyclical rotations (like with energy stocks during the past 18 months), the best investments are in fact "new breed" companies that are directly levered to emerging societal and business trends.

The biggest problem with the best-of-breed concept is the term itself. How does one even define best of breed? Is it the company that delivered the best shareholder gains over the past five years? The company that makes the best products? The company that stays on top of the Fortune "most admired companies" list? The company with the highest ethical standards? The company with the highest organic growth rate in the industry? Or the company that merely did well last quarter?

While calling a company "best of breed" is often a way of saying a company has done well in the past, in the worst cases the phrase becomes an excuse not to do comprehensive research on that company to discover if its past successes can continue.

Take the case of Intel (INTC), a company that many call "best of breed" in the semiconductor space. But why? Because Intel ruled the 1990s? Advanced Micro Devices (AMD) has been outperforming Intel in terms of product innovation and shareholder returns. Could it be that calling a stock "best of breed" provides a convenient excuse in the case of disaster or underperformance?

"How did I know company XYZ wouldn't do well? It's best of breed!"

So what exactly is a "new breed" company? Like "best of breed," it's difficult to define. But my general view is that a "new breed" is a smaller, off-the-radar company with strong fundamentals that is benefiting from an identifiable trend. While it's not ideal to replace one difficult-to-define term with another, I sincerely believe new breed is a far superior concept to best of breed.