The Best Stocks to Own (Hint: They Are Not the Most Widely Held)

NEW YORK (TheStreet) -- As a professional money manager over the last 18 years, I have sat across the desk from thousands of prospects and clients. I hear a lot of the same stories over and over again. I believe that that there is a very important lesson that I can impart to you investors, who are now reading this article.

I can remember watching one of the greatest comedians off all time, Johnny Carson, as he did one of his signature sketches, "the Great Karnak." Johnny would hold a sealed envelope up to his forehead and seemingly be able to read what was inside.

What does this have to do with the stock market and investments you ask? Well, let me tell you. I run a smaller boutique advisory firm in San Diego that is far away from the noise of Wall Street. Oh, I have been back to floor of the Stock Exchange many times. I am also connected on a daily basis through all of the major financial networks beaming through the televisions in my office. I have also appeared many times on those same networks through my West Coast hookup, but the proximity ends there.

Prospects generally come to me for one of two reasons: They are not happy with their current advisor or they are weary of trying to manage their own money. They have found me through my radio show, my weekly newsletter, the app that I invented, or media appearances. They usually tell me that I talk about stocks that they do not hear about in the mainstream financial media.

This is where the "Great Karnak" story comes in. I can literally hold their big wire house firm brokerage statement up to my forehead and see most of the stocks that are in their portfolio without looking.

I see General Electric ( GE).

I see Merck ( MRK).

I see Pfizer ( PFE).

I see Cisco ( PFE).

I see Johnson & Johnson ( JNJ).

And on, and on, and on...

Why should that surprise anybody? When I turn on the major financial networks, I hear the same stocks being talked about over and over again. When I read most of the big publications that follow the markets, I see those same stocks yet again. What is wrong with the big widely held names you ask?

Let me answer that question with some pictures, because pictures speak a thousand words:

All data from Best Stocks Now App

If I have made you squirm a bit, then I am doing my job so far. I want for you to focus for just a minute on the PERFORMANCE of these stocks over the last 1, 3, 5, and 10 years. I also want you to look at the RELATIVE PERFORMANCE grade of these stocks when I compare them against the other 2,800 or so stocks that I follow.

You may be thinking: "But these are big well-known American icons that aren't going away like some of the lesser known stocks out there, they are safe." Note that GE and Merck severely underperformed the market during the extreme duress that the market was under in 2008, you call that safe?

Now let's look at some pretty pictures that we can contrast with the not so pretty ones with:

Wow, what a difference! The best stocks in the market are generally just under the radar. They should not be, but for some reason they are.

When I start telling folks that some of the great stocks of our day are Dollar Tree ( DLTR), Autozone ( AZO), Terra Nitrogen ( TNH), Ross Stores ( ROST), Family Dollar ( FDO), Monster Beverage ( MNST), Tractor Supply ( TSCO), etc., etc., etc., unlike the Great Karnak, they scratch their heads and say, "I didn't know that! Why don't I own any of these stocks?" Sometimes they start getting really agitated and start wondering why they own all of the usual suspects instead. They feel like they have been duped.

You see, companies have life-cycles. They usually start out as a great idea by a few entrepreneurs like Steve Jobs and Steve Wozniak. They begin their life as private companies. The entrepreneurs next invite investors in, while the company is still private. These are the investors that take the greatest risk, but stand to reap the greatest reward if the idea works out.

If it is a good idea, the company will file for an initial public offering and only a select few will get in at the offering price. These folks also stand to reap an outsized reward. On IPO day, many get caught up in the frenzy and buy way above the offering price. This is rarely a wise thing to do.

The company is now a publically traded company and enters into the realm of the retail investor. It now has to prove to investors that they can grow their sales and earnings at a steady clip, thereby increasing the value of the company to the shareholders. Some do very well at this, many do not. If you are a growth investor, you want to own the very best ones, when they are still in their prime.

The best ones can go through several years of phenomenal growth as the stock goes from a small-cap, to a mid-cap, to a large-cap, and even sometimes to a mega-cap. Cisco would be a good example of this. Unfortunately, all good things must eventually come to an end and mathematics begins to catch up with the company. High double-digit percentage quarter-over-quarter increases in earnings are no longer possible. Consider that Cisco has only been growing its earnings by 5% per year over the last five years.

EARNINGS GROWTH TRANSLATES INTO STOCK PRICE APPRECIATION!

Once those earnings begin to significantly slow down, the growth investor should move on and leave the stock to the value investors. Sadly, a large or mega-cap stock that is now growing at a single-digit annual pace next enters into a new realm, that of a widely held stock.

That is not to say that one cannot make money in a widely held stock, especially if you can buy them when they are severely beaten up, but I prefer to shop in other aisles of the stock market. I prefer to own stocks that possess both performance and value.

If we buy stocks just because of performance and ignore value, we are momentum investors. I think that we found out a lot about the importance of valuation back in the Nasdaq crash of 2000-2002. We also learned that same lesson again in recent years in the housing market. Value is very important.

I have found however, that many so-called grossly undervalued stocks are nothing more than value traps. What is wrong with combining the best of performance investing, but also paying attention to value? Let me cite Polaris Industries ( PII) as an example:

I wrote about this rugged American-made stock back in early December of last year. The stock was trading at $59.80. The article had very few page views, I was after all not writing about Cisco. The stock closed at $80.00 on Friday, but it still exhibits the best of worlds, performance plus value.

You can easily see how the 1, 3, 5, and 10 year performance has clobbered the S&P 500. You can also see that despite the recent big advance in share price the stock still has a favorable PEG ratio of 1.05. Also, when I extrapolate out current earnings at the growth rate estimate of the analysts, and apply a reasonable multiple, I still see significant upside potential in the stock over the next five years.

It is your choice, you can fill your portfolio with names that are familiar and widely-held, or you can dig a little bit underneath the surface and find stocks that are still in the prime of their lives. Sit back and take a big gulp of fresh air, because in future articles I am going to do my best to point you in the right direction of the BEST STOCKS NOW!
Disclosure: At the time of publication, Gunderson was long DLTR, AZO, TNH, ROST, MNST, TSCO and PII.