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Finding 800 Percent Gains With Little Risk

Today, I will tell you how to catch lightning in a bottle. This is a technique you can use over and over again. I discovered it myself gradually – but this logic became crystal-clear to me with Crescent, a real estate investment trust (REIT) that caught my attention about a year ago.

Crescent had outstanding value numbers, including a low price-to-earnings (P/E) ratio, big margins, and a good cash flow. But what I really liked about it was that its price had dropped about 40 percent from its peak. So – after doing my research – I selected the stock and saw the company’s price increase … 13 percent that month … 11 percent the next month … and it just kept on climbing.

Recommending an investment in this company didn’t take blind faith or nerves of steel. From my research, I knew that it had put its problems behind it (mainly by welcoming back its original CEO). And it wasn’t hard for me to anticipate the company’s resurgence, because I understood that – with companies that have been beaten down – Wall Street eventually recognizes that they have rediscovered how to use the assets that made them so successful in the first place.

A big part of investing is choosing the right company at the right price point. The time to buy Google, for example, has come and gone. Last year, the right company. This year, the wrong company.

Take, for instance, Warren Buffett’s Berkshire Hathaway company. If you’d invested in Berkshire in 1965, you would have made 1,900 times your money by now.

Berkshire’s stock investments comprise one of the best-known portfolios around. But its huge success has to do with more than just good timing. Unlike many investors who sweat over the precise timing of when to jump into a stock, Berkshire focuses on finding the right companies at the right price. The timing takes care of itself.

Look at the huge gains Berkshire made in so many companies (American Express and Moody’s are two that made long, steep climbs while they were part of the Berkshire portfolio) and you’ll instantly realize that it doesn’t really matter that Berkshire could have done even better had it bought a particular stock two months earlier or two months later.

You usually don’t have to wait for the stock to bottom out – or to bottom out and begin to turn around – as long as you like the company’s fundamentals, management, and growth plan.

But there’s one big exception to this rule. When a stock has taken a monumental dive – losing more than half its peak value – you need to approach it with extra caution. And you should wait for the stock price to turn back up before you take any action.

With companies that have had enormous drops, even this cautionary step is not enough. Such a dramatic fall signifies a serious problem. It could be an accounting scandal, a CEO on the take, diminishing revenues or profits, products with outdated technology, or just plain bad publicity.

Even when you wait for a stock to go back up, it’s possible that its rise could be based on temporary good news. If so, the stock’s improvement could be temporary too.

So why bother with such companies if they’re so risky?

Because if you can be sure a company that has fallen on hard times has taken care of whatever problems it’s been facing … that its price turn-up isn’t just a “dead cat’s bounce” … then congratulations are in order. You’ve just caught lightning in a bottle.

Let’s say a company’s shares drop from $50 to $2 and then click up to $4. At $4, you can be much more certain than you could have been at $2 that its problems are now part of the past. You may have missed out on the initial 100 percent gain, but now – at much less risk – you can easily ride the stock as it surges up to $10 (or perhaps much higher). From $4 to $10, you’ve still made a 150 percent gain. And if your stock rises to $40 – still $10 off its peak – you’ve made an 800 percent gain.

Borrowing some of Berkshire’s most conservative investment principles and using them to X-ray a group of companies straining at the bit to regain their former glory … to separate the diseased from the fully recovered, and then ride those healthy, reinvigorated companies as they surge to new heights … is the surest and safest way to make remarkable returns. (And, by the way, with The Wealth Advantage – the new investment service that I’m offering to all ETR readers – I’ll be doing all the work for you.)

Getting back to Berkshire …

Berkshire’s portfolio of 33 stocks (worth $42.7 billion) was bought over a long period of time. It began buying shares of its “big four” companies – American Express, Coca-Cola, Gillette, and Wells Fargo – back in 1988. But a stock bought 10 or 15 years ago is ancient history. And one purchased 1-2 years ago (again, think Google) might as well be ancient history.

Of those 33 stocks, five are relatively new investments: Home Depot (HD), Lexmark International (LXK), Tyco International (TYC), Anheuser-Busch (BUD), and Kingfisher (KGFHY).

Please don’t go rushing out to buy these companies. Only one of them is worth considering. (More on that in a second.) The Anheuser-Busch stock, for example, has shown surprising weakness since Berkshire bought it. And there are problems with three others.

Over the last 25 years, Berkshire’s portfolio has lost money in just three stocks. In that span, it averaged an annual return of 20.3 percent compared to the S&P 500’s average of 13.5 percent.

But listing the remaining 27 stocks in the Berkshire portfolio isn’t going to do you much good … except to satisfy a curiosity about which stocks are in this top-performing portfolio. None of these companies offer outsized returns sooner rather than later.

The 20.3 percent annual return that the Berkshire portfolio has averaged is very impressive. But for even better gains – much better gains – the way to play this game is as follows:

* Look for new people and strong ideas. I just don’t believe it when the old management team says they got religion and they can resurrect the company.

* Make sure the company operates in an exciting market. A surging market helps upside. And it makes it easier for a company with something to offer to grab market share.

* Uncover a potential for huge profit. An idea, product, technology, asset – the company should have SOMETHING up its sleeve that can pay off really big.

Searching for companies outside of Berkshire’s portfolio with the above three things in mind, I’ve come up with three probable lightning strikes.

One company is a multi-billion-dollar technology firm in the making … and yet its market cap is less than $90 million. The company was brought down by a combination of bad management moves and the tech crash. It now has a new CEO who is a proven turn-around artist. The company has more than 100 patents (more than one of which has billion-dollar applications).

Another company – this one is in real estate – had record-breaking earnings last year. Yet the stock fell more than 50 percent between September and March of this year – in part on fears of the “real estate bubble.” But demand for its products greatly outstrips supply, and the majority owner of this company thinks it is such a screaming bargain that he wants to buy the whole thing. This company could easily double in price in the coming months.

The third company is no stranger to success. Microsoft, Apple, Sony, Yahoo, Napster, TiVo, and Walt Disney are all collaborating with it. And it has grown earnings by 20 percent or more for longer than a decade. And yet … since the beginning of 2004, the share price has fallen more than 44 percent. The company has NEVER had a lower valuation than it does right now, and its prospects have never been greater. If its shares were priced in accordance with the real value of its assets, they would go up more than eight times current levels.

These three companies have the very real potential of giving you up to 1,000 percent returns on your investment. You can read more about them in a special free report. You get the report when you join our new elite investment service – The Wealth Advantage – which will show you how to invest like Warren Buffett … but with a much higher upside.

“My mother always told me I wouldn’t amount to anything because I procrastinate. I said, ‘Just wait.'” – Judy Tenuta

Andrew Gordon

Andrew Gordon is a former editorial contributor for Early To Rise Investor’s Edition. He has 20 years of experience working in infrastructure and environmental projects around the world. When he wasn't traveling, he taught marketing and finance courses at the state university of Maryland. Mr. Gordon has authored several books for McGraw Hill and other publishing companies on energy markets, global countertrade practices and the hot growth sectors of China and Russia. He is also a top-rated speaker at financial conferences.