For Breakout Results, Go With These Stocks

Developing a winning strategy for selecting growth stocks is often an arduous task, but an effective research process can make it much easier. No two investors may pick stocks the same way, but it's important to find out what works for you.

One way to begin is to look at some of your past winners and identify the process you used to find them. This is a good assignment for any investor, no matter how experienced or successful. So, with that advice, let me explain how I research stocks and how I came to invest in a stock that delivered a huge return.

My primary task here at TheStreet.com is to manage the Breakout Stocks newsletter service. I look for small- and mid-cap companies that are direct beneficiaries of growth trends within the economy. I do not make big-picture bets on large macro trends such as rising consumer electronics sales.

Instead, I like to dig deeper and look for the micro trends that can't move the needle for a big company but can easily drive significant growth at a smaller company. This maxim helps me tremendously; using it, I can ignore 95% of the stocks on the market and spend my time looking for the 5% that are showing outstanding growth.

With a greatly narrowed stock universe, it is much easier to find what I am looking for. Last year, one of our most successful positions was video-game retailer GameStop GME, which rose 125% in 2007, as demand for hot video-game products like the Nintendo Wii console boomed.

Now the Wii did benefit retailers like Best Buy BBY and Wal-Mart WMT, but given my very bullish outlook for video-game sales, it made infinitely more sense to focus on a stock levered 100% to video-gamers. GameStop was the obvious choice.

GameStop became the biggest driver of the Breakout Stocks model portfolio, which returned 13.5% in 2007 compared with 1.4% for our benchmark, the Russell 2500. (Please click here if you'd like to take a free trial of the Breakout Stocks service.) Naturally, not all of the stocks in the model portfolio performed as well as GameStop, but given the solid return of the service, my research process was working nicely.

Here is how I research stocks. Once the stock universe has been narrowed, my next step is to observe the world and its markets to examine how they are changing. In recent years, emerging-market economies like China have joined the world's stage; commodity prices have skyrocketed, and technology has advanced in ways few of us could have predicted.

I pay special attention to the actions of large, diversified companies. For example, General Electric GE can give investors insight into what is happening in various sectors, including financial services, aerospace and infrastructure. In turn, investors can take that information and look for plays on the stronger segments of GE. The company's infrastructure segment, in particular, has been exceedingly strong but not quite strong enough to offset weakness in financial services.

As a result, GE's stock stagnated in 2007, while infrastructure stocks like Foster Wheeler FWLT and Willbros Group WG simply went through the roof. You can often find the strong sectors and weed out the weak ones by examining the individual segments of large, diversified companies. The weak results in financial services at companies like GE were one reason I was significantly underweight financials throughout 2007.

At the same time, I always perform extensive research at the company level, placing utmost importance on a company's financial stability, competitive positioning and track record of success. I also place great emphasis on a company's ability to generate upside earnings surprises, which is a key element in growth stock performance.