May 17, 2011 - Most investors have a tendency to think their investments will do better than the average return on stocks. That they can pick winners that will outperform most others. And why not? They've done their homework, analyzed all the data, discovered a hidden gem that is waiting to explode into the investor firmament, highlighted on all the talk shows and pushed ever higher. And they already own it.

The reality is that just beating the average return on stocks is hard to do. Ask any mutual fund manager who spends all waking hours scouring over data, looking for exceptional stocks and rarely finds one. That's because the real numbers look like this:

The Average return on Large Cap stocks has, depending on what decades you want to include, been about 11% a year. (Cap refers to Capitalization which is the price of a stock times the number of shares outstanding) Large caps are usually over $10 billion. The average return for Small Cap stocks has been about 12%. (Small Cap is between $100 million and $1 billion)

Those are averages. That means if your portfolio returns over 12% a year, you're doing better than most other stocks. What does 12% look like? On a $10 stock, it's $1.20. On a $50 stock, it's $6. So if your stock goes from $10 to $11.30 (omitting commisions) then you've done quite well.

You can actually beat the averages for stocks by buying certain high-yielding stocks or bonds, ones that pay above the average stock market returns. But they carry a lot of risk. A whole lot of risk. Currently certain real estate investment trusts pay more than stock average returns. But then how long they can pay those levels is the real question. Most investors feel not for very.

So how do you find stocks that can beat the average returns? It's all in the earnings. Stocks that grow earnings at an increasing rate will always be given above average P/E (price to earnings ratios). Of course, some stocks will have extremely high P/E ratios even before they grow earnings because investors think the earnings growth rate will be astounding once the company fully exploits its potential. Think of biotech firms with promising drugs that have yet to be approved. Or ones with approved drugs that are building facilities to produce a promising cure. (An example: Dendreon (DNDN)....which I own).

Other examples of solid growth, even in these tough times are: Mattel (MAT) (large cap), Genesco (GCO) (small cap), Collective Brands (PSS) (mid-cap). These are all featured in this week's columns on The Online Investor.

Will they all beat the average returns for stocks? I certainly don't know. But their price patterns over the last 18 months certainly has. Whether it continues into the future is what investing is all about: trying to find the winners. And when you do, keeping your expectations real.

- Ted Allrich