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    In early 2009, I decided to see if I could outperform the S&P 500.  My portfolio grew by 34.03% in 2009 and 43.95% in 2010.  According to E*trade, the S&P 500 Index was up 23.45% in 2009 and 12.78% in 2010.

    These were my guidelines:

    • Picking investments is hugely uncertain, so, instead of trying to become a guru about everything, I would look at oblique indicators like whether the gurus running the companies were selling.
    • No one knows why entire markets go up and down, but companies are discrete investments that sometimes make sense.  The rising and falling tide affects all boats, but some boats have sound hulls that will outlast the storm.
    • I would ask myself every day if I would buy my stocks that day.  If I would not want to buy my current stocks, I would consider selling them.
    • Stocks are like model rockets:  their little engines lift them up, they coast upward on a delay charge, and then the ejection charge blasts out the parachute and they float down.  I would allow for some coast, but would sell quickly if I felt conditions changed.  I would try not to lose money.
    • I would diversify in 20 or 30 different positions.  When I am most certain, I am usually most wrong, so a big bet is often a bad one.  Being wrong can happen for random reasons:  I once bet big on Pinnacle Micro, the first maker of rewritable CDs.  Pinnacle cooked the books, the auditors quit, the lawyers sued, and a death spiral followed.  Who knew these former HP execs would behave so badly?
    • I would look for Perfect Companies.  There are so many opportunities that I ought to be able to limit my risk by buying only companies that were near perfect.

    These are my conditions for the Perfect Company:

    I want a company that can grow quickly.  There are great car dealership chains, but they aren’t likely to double and triple in sales overnight because they’d have to build lots of new, expensive car dealerships.  This means I look at technology, software or concepts that are easily scalable.

    I like entrepreneurs.  Despite the prevailing idea that MBAs can run anything, I observe that the real fortunes have been built by people who were not taught what they cannot do; many never bothered to finish college:  Gates, Dell, Ellison, Jobs, Zuckerberg.  I would rather invest alongside entrepreneurs and owners than professional managers.

    I hate insider selling – I don’t mean car and college money; I mean that when the chairman and CEO of Luecadia (LUK) both sell $50 million in stock, it’s time to take whatever price you can get and run away.  I once owned a great company called Loopnet, but every insider who was ever involved hated that company: they sold it all the time and finally unloaded the rest in a merger.  A stock price can’t go up if the insiders are always dumping, so, no matter what the fabulous story, I won’t get involved if the insiders are selling.  There are too many other opportunities.

    I like dividends.  Yes, it would be terrific to grow those funds inside the company, but, if you were an owner and you could generate lots of cash, wouldn’t you rather get some cash for your shares than be forced to sell shares to finance your lifestyle?  If banks are paying virtually nothing, and I can get 2-3% dividends for a great company, I’m happy to wait until other people discover my investment.  Besides, it keeps owners from selling their shares.

    I like cash, which goes well with dividend-paying.  Even better:  lots of cash and no debt.  Sometimes, you can find companies with more cash than market cap like IDT in 2009.  The entrepreneur who ran IDT had several great successes, but at that time was so disliked that the market valued his company at less than its cash.  I bought at 2 and sold at 16 – about the time Forbes decided to highlight this fantastic opportunity.  Having cash also means that the company will probably survive the next blind-side disaster.  Tsunamis?  Greeks won’t pay their taxes?  Honeybees disappearing altogether?  If there’s cash in the bank, my perfect company will have a chance to recover.  In fact, it may do even better because it will have buying opportunities when its competitors can’t breathe.

    I like increasing sales and profits.  If sales are increasing, people want what the company is selling.  If my perfect company makes money, then I can sleep at night:  who cares if the price fluctuates if my company makes money, has cash, is growing and pays rent on my investment?

    Finally, I like small and mid-sized companies with market caps from $100 million to $5 billion.  These companies have room to grow, and are great acquisition targets for the behemoths that can only move the needle by bolting on other companies.  One day, you get the news that your investment has doubled.

    My First “Perfect” Company

    Almost no companies have met all my specifications, but the one that has come closest is Communications Systems (JCS).  A maker of networking equipment, JCS has a market cap of $161 million, cash of $35.5 million, Q1 ’11 sales of $31M versus Q1 ’10 sales of $26M, and Q1 profits of $4.1M in 2011 versus $2.1 in 2010.  It also pays a 3.13% dividend.  The chairman actually buys shares and owns 1.1 million of the 8.4 million shares.  I first bought JCS at $12.89, bought more when it declined to $10.23, and, when JCS moved up versus a down market, doubled my position at $18.53.  It’s at $19.15 today.

    Each week, I’m going to recommend one company in this space.  If you’ve got a Perfect Company to recommend or an idea about what makes a Perfect Company, I’d like to hear from you at