CEO Tom Gardner: "Look Where Others Aren't Looking" to Beat the Market Over the Next 3 to 5 Years

Key Points

• The market may be entering a period of subpar performance for growth stocks.

• Safer, income-oriented holdings may be on the verge of a market-beating phase.

• This may be a good time to invest in companies that are more off the beaten path.

• 10 stocks we like better than Schwab U.S. Dividend Equity ETF ›

Want to beat the market? Most investors do. It's just easier said than done. Indeed, the risk and effort needed just to attempt to outperform the market can easily result in your underperforming it. That's why plenty of investors are content to merely match the stock market over the long term by buying and holding index funds.

Every now and then though, it makes sense to rethink the strategy of simply investing in the market as a whole or owning its obvious leading names. This may be one of these times.

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That was the key takeaway from a recent interview with The Motley Fool's co-founder and CEO Tom Gardner. "If you're looking for good returns over the next three to five years that beat the market," he said, "I think you need to look where others aren't looking right now." And he's right.

The question is, what does this mean in practical, actionable terms for the average investor? To answer that, it's helpful to first look three to five years back in time, and then, look back a bit further.

Not the long-term norm

As it is in life, the one constant in investing is change. The way things are now isn't the way they were in the past, nor is it the way they'll be in the foreseeable future. One only has to look back over the past few years to see it.

The so-called "Magnificent Seven" stocks (and their close peers) that have performed so brilliantly since 2020? They weren't exactly superstars in the years prior. Apple was hit-and-miss between 2012 and 2016, for instance, against a backdrop of slowing iPhone sales. Nvidia shares, which soared in the mid-2010s, were wrecked in 2018 when the crypto-mining craze cooled off. Meta Platforms (then Facebook) and Tesla performed equally inconsistently during the half-decade leading up to 2020, even if for different reasons.

But all of these powerhouses happened to benefit from a confluence of events: the explosion of artificial intelligence, rising interest in electric vehicles, and even demand driven by the advent of the COVID-19 pandemic. And due in part to their size, the raw strength of those few companies set the bullish tone for the rest of the market.

AAPL data by YCharts.

That upward push wasn't particularly healthy or sustainable, however. Indeed, it has arguably been unhealthy, by virtue of the lack of overall contribution to it by a broader group of stocks.

For perspective, the S&P 500's seven biggest names today account for roughly one-third of its total value. Most of "the market's" bullishness in recent years was propelled by the aforementioned Nvidia and Meta, along with Microsoft and Amazon -- their far-above-average gains had an exaggerated impact on the S&P 500's performance specifically because they make up such large portions of the cap-weighted index.

To further clarify this, while some of these megacap stocks may now be back to record highs thanks to their big recovery from April's lows, fewer than a tenth of the S&P 500's constituents are actually in record-high territory. Nearly half of the index's tickers are still in the red for the year, in fact.

In short, the S&P 550 -- our most common proxy for the market -- has performed well for a while now thanks almost entirely to the gains of a handful of growth stocks in an environment that firmly favored them. That sort of cyclical dynamic can't be expected to last forever.

Here comes the cyclical shift

So now what?

Broadly speaking, some of the key conditions that tend to move growth stocks out of favor are already in place. Interest rates are higher and the economy has shifted to a slower-growing -- even if stable -- scenario. It's worth adding that the mania for artificial intelligence is finally settling down, with no obvious new trends on the horizon to stoke unchecked bullishness. Previous manias like electric vehicles and renewable energy aren't apt to be renewed either.

Ergo, without anything new or exciting enough to make investors ignore companies' lack of profits or outrageous valuations, Gardner believes "you need to look for dividend payers, more value-oriented investing," which rewards basic attributes like predictability and profitability. Something as simple as the Schwab U.S. Dividend Equity ETF (NYSEMKT: SCHD) or the Vanguard Value ETF (NYSEMKT: VTV) would fit the bill.

Image source: Getty Images.

Picking stocks that are likely to be among the best performers for the next three to five years doesn't necessarily need to be a black-and-white, value-versus-growth affair, however.

"There are hundreds of good stocks to buy right now and own for the next five years, but they're probably not the most well-known [or] actively followed," said Gardner. "It's probably where people aren't looking. It's probably small caps. It's probably under-followed names."

Translation: Focus less on the now-struggling Magnificent Seven and FAANG components that have been considered must-have holdings for most of the past five years, and instead focus on the stocks of companies that are thriving even without the limelight.

Such businesses perhaps to consider now range from utility giant NextEra Energy to online bank SoFi Technologies to supermarket chain operator Kroger to beverage and snack powerhouse PepsiCo (which at its current share price is yielding 4.2%). These are relatively boring companies, but there's nothing boring about beating the market.

Take your time, but do embrace the change

So should this be an all-or-nothing strategic shift in your portfolio? No. Gardner is not suggesting any investor should simply upheave all of their familiar growth names and replace them with value stocks or dividend payers. Some growth stocks will perform well for the foreseeable future even if most large-cap growth stocks don't. Every prospective stock pick should still ultimately be made on a case-by-case basis based predominantly on the company's particular merits and prospects.

Investors should now be embracing a new philosophical mindset, though. Much of what has worked well in recent years -- like latching onto the market's biggest companies as they got bigger thanks to the advent of AI -- isn't apt to work as well going forward. Value stocks, dividend payers, and the more obscure stories may be better positioned to perform from here. Be sure to adjust your portfolio accordingly.

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Randi Zuckerberg, a former director of market development and spokeswoman for Facebook and sister to Meta Platforms CEO Mark Zuckerberg, is a member of The Motley Fool's board of directors. John Mackey, former CEO of Whole Foods Market, an Amazon subsidiary, is a member of The Motley Fool's board of directors. James Brumley has no position in any of the stocks mentioned. The Motley Fool has positions in and recommends Amazon, Apple, Meta Platforms, Microsoft, NextEra Energy, Nvidia, Tesla, and Vanguard Index Funds-Vanguard Value ETF. The Motley Fool recommends Kroger and recommends the following options: long January 2026 $395 calls on Microsoft and short January 2026 $405 calls on Microsoft. The Motley Fool has a disclosure policy.