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How many stocks do you own that are up 10-fold or more?
If your answer is “none,” lend an ear. Because the best-managed equity portfolios aren’t made up of tons of stocks that are up 30% or 50%.
It’s far more likely that they have a lot of middling performers… and a few huge gainers that dramatically increase total returns.
If you doubt it, just ask Peter Lynch, the greatest mutual fund manager of all time.
During his tenure at the Fidelity Magellan Fund from 1977 to 1990, assets grew from $18 million to over $19 billion. This was partly because he earned a 29.2% compounded annual return, a record that remains unmatched in the mutual fund industry. And partly because shareholders continued to invest new money in the fund.
What was Lynch’s great secret? He was a master at identifying successful growth stocks or, more particularly, hypergrowth stocks.
In his book One Up On Wall Street – still an investment classic – Lynch coined the term “ten-baggers.” That was how he described stocks with prospects so explosive that they had the potential to rise 10-fold or more.
Lynch invested in many of these during his time at Magellan. And in recent months, my research team and I have been poring over the ten-baggers of the last few decades to learn everything we could about them.
Although you would recognize some of these stocks – like Priceline (Nasdaq: PCLN) andNetflix (Nasdaq: NFLX) – the vast majority are not household names, even though their share prices have risen 10-, 20-, 30-fold or more.
And here’s the important thing: Although these were different companies, in different industries, run by entirely different people, most had several characteristics in common both before and during their dramatic runs higher.
We isolated these characteristics and turned them into six investment criteria – a starting checklist if you will – to guide us toward the “Ten-Baggers of Tomorrow.”
Here are some of the characteristics we found that ten-baggers typically have in common:
- They are tremendous innovators. Companies that rise 10-fold or more offer revolutionary technologies, new medical devices, blockbuster drugs, and other state-of-the-art products and services. Over the last 10 years, for instance, investors have been stunned by the moves up in Tesla (Nasdaq: TSLA) with its electric cars, Apple(Nasdaq: AAPL) with its cutting-edge electronics, and Amazon (Nasdaq: AMZN) with its breakthrough e-commerce platform and one-click ordering system.
- They experience terrific sales growth. Notice I said sales growth not profit growth. A lot of the best-performing companies were not profitable in the early stages of their run-ups. But even if they were losing money, they usually experienced top-line growth of 30% or more.
- They protect their margins. Huge sales numbers attract competition the way honey attracts bears. That means a firm has to be able to protect its innovation with patents, brands and trademarks. Otherwise, competitors will flock to the industry, grab market share and force down margins.
- They beat consensus estimates. Some investors think earnings alone propel stocks higher. This is largely true over the very long term. But in the nearer term, it is all about beating expectations. Even if a company loses money, if the loss is smaller than expected, it can register as a significant beat. That means the shares are likely to push skyward.
- They are small cap to midcap companies. It will not surprise you to learn that most of the best-performing stocks of the last few decades started out as small companies. A study by the Chicago research firm Ibbotson Associates reveals that every dollar invested in a basket of large cap stocks in 1926 and held through the end of May of this year – with dividends reinvested – would have grown to more than $5,200. But every dollar invested in a basket of small cap stocks would have grown over the same period to more than $25,100. Huge companies simply can’t grow at the breakneck pace of smaller companies.
- They are relatively unknown. The fewer people who understand what a company is doing – and the less media attention and Wall Street coverage it gets – the better the chance that the shares are mispriced. Hot stocks with splashy stories have not been the best performers, historically. By the time a company becomes widely known, much of its parabolic move higher is generally over.
It’s been said that one good speculation is worth a lifetime of prudent investing. And it’s true.
Just imagine what a few stocks – or even one – rising 10-fold or more would do for your portfolio’s total return.
A couple years down the road we will stand in astonishment at the market’s best-performing stocks.
Our ten-bagger criteria helps you start identifying them today.