Although it’s easy to forget sometimes, a share is not a lottery ticket… it’s part-ownership of a business. — Peter Lynch
Wouldn’t it be nice to have a sixth sense to invest in the next 10-bagger stock? In the past 30 years alone, we have witnessed birth and rise of many 10-bagger stocks such as Microsoft, Cisco, Dell, Qualcom, and Apple.
The term 10-bagger was coined by Peter Lynch in his best-selling book ‘One Up On the Wall Street”. These are the stocks that go up 10 fold in value from the purchase price.
These stocks are like supernovas in the Milky way. Their meteoric rise and spectacular return can make you a millionaire, if you are lucky to find one of these stellar investments in your life time.
The easiest way to build wealth is to have the foresight and courage to invest in one of these revolutionary companies for a decade or longer while its business model transforms the world.
If you had invested just $5,000 in Microsoft stock in 1986, it would have been worth over $1.7 million now. If you were lucky to sell it at its peak in year 2000, you would have made over $3.4 million from your humble investment of $5,000. That’s the power of finding and holding on to a revolutionary stock.
Let’s face it, it’s not as easy as it sounds. It’s clear from the fact that most people get mediocre return from their investments. As an astute student of life, I embarked on finding a recipe for the next ten-bagger.
We can’t profit from the supernovas of the past, but we can use our analytical mind to find common factors among these outstanding investments to look for the next Apple to profit from.
William O’Neil is founder of Investors Business Daily. Like a street smart investor, Mr. O’Neil has been a staunch believer in collecting data and finding facts instead of relying on the personal opinions or feelings of the Wall Street analysts.
Based on the research of IBD, you can use these rules to find the next 10-bagger stock because history always repeats itself.
1. Find a revolutionary company with exceptional business model.
The touchstone of any revolutionary company is its power to change the world by offering a revolutionary product or service. These companies enjoy unique competitive advantage due to their ability to create a new niche. Microsoft was a tiny company in early 80’s, but it became a game changer in the personal computing world when IBM licensed the Windows operating system. Instead of selling Windows operating system to IBM, Bill Gates struck an exclusive licensing deal to become the richest person on the planet. Those who invested even a paltry $5000 would have been millionaires by now.
Cisco systems revolutionized networking by offering routers in early 90’s right before the Internet boom. It’s stock zoomed up 75,000% in that decade.
2. EPS(earning per share) should grow at 25% or more.
The bye product of offering revolutionary product is the revenue and sales growth. It’s important that EPS grows at 25% clip or more compare to the same quarter a year ago. All the great stocks show EPS growth consistently for many years to reward their investors.
3. Sales should grow at 25% or more.
Both earnings and sales normally grow in tandem. Apple is a classic example in the recent time. It’s EPS and sales have grown by more than 25% since 2007. Obviously, the stock price reflects that growth since 2007.
4. Return on Equity(ROE) should be 20% or higher.
Return on Equity shows how effectively a company is utilizing its capital to increase its top line growth. This is one of the crucial factors for a young company to show that it can invest capital wisely during its growth years. It also demonstrates quality of the executive leadership.
5. The stock should have institutional sponsors.
It’s important for any stock to have institutional sponsors like mutual funds, insurance companies and banks. These sponsors have financial power to accumulate large number of shares; it is inevitable for the stock to advance due to the purchasing power of these professional investors.
Parting Thoughts:
From the Industrial revolution to the Internet revolution, scores of companies led these times to change our world. You really don’t need the genius mind of Steve Jobs or Jeff Bezos to build wealth. You simply need a street smart attitude to invest early on in these revolutionary companies to become rich. Do you agree?
Elsewhere:
Start Your Investment Portfolio with One Share of a Stock @ Your Smart Money Moves
Thoughts About Investing @ Modest Money
Dividend Growth Investing @ JlCollinsnh
The Little Book of Big Dividends @ My Money Design
How Often Should You Re balance Your IRA And What Funds Do You Choose? @ Eyes On the Dollar
Photo: Microsoft Stock Chart
OK. A couple of questions.
1. For how many years does the company have to produce 25% EPS & sales growth and 20% ROE before you decide it’s the real deal and not a flash in the pan?
2. How much institutional support to establish the trend is real but before the money’s been all made? Institutions buy lots of companies that don’t work out, too.
3. What are the names of the next Apple/Google/Microsoft/Amazon/Cisco type companies that fit this profile now?
That last question is the important one! 🙂
Great questions, Jim!
1. You want to see accelerating earnings and sales growth for six to eight quarters consistently before considering that investment.
2. There are no set rules for the Institutional sponsors. According to IBD, you want to see growing interest not because they are correct all the time, but because of their purchasing power. Simply put, more dollars chasing for less shares outstanding or the float can push the price higher.
3. I can definitely get into trouble to divulge into this question. 🙂
RE: #3 — you are definitely ‘street smart’!!
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Thanks for including my article in your resources!!
Keep up the good work, Ted!
I like these, Shilpan, but would offer one more: know the company. I’ve seen too many investors jump on “the hot thing” because “so-and-so likes it” and it checks all the boxes, but the investor knows zippo about the end product. It’s hard to know when it isn’t working if you don’t understand at least a little about how they actually make money.
Well said, Joe! You have to know business model. In fact, Peter Lynch’s quote in the beginning on the article says it all.
Someone really likes growth stocks! And I don’t blame you. I’m more of a value investor, so the numbers I’m looking for are a little more modest. Thanks for the mention !
I really enjoyed your article, MMD!
Even I could find great companies (I did invest in AAPL before it was ‘cool’), the problem is knowing when to sell. Especially true with tech companies. They have relatively short life spans. Even mighty KodaK and Polaroid bit the dust.
sometimes when I read other article on investing in companies they focus on the P/E ratio. As you know, it doesn’t provide a clear picture of the value of the company and it’s potential or success. I agree with Average Joe, you do need to know how the company makes money.
Very good article!
I’m going to tweet your post so my husband can read it – yeah it’s how we communicate. He’s a big fan of Peter Lynch and investing in 10 bangers so it’s a great fit!
Thanks for the financial knowledge!
Thanks for the tips, Shilpan. Do you have any insights on who the next 10-bagger will be?
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Finding the next ten bagger stock thats a stock thats seen a ten fold increase in the price of its shares. I have always used a simple metric to measure how undervalued a stocks is.
And that metric is the price to sales ratio. The one thing about buying stocks with very low price to sales ratios is you will have the odds on your side when you buy stocks with very low price to sales ratios. If we take a look at a couple dozen or so stocks that are ten baggers today we will most certainly will find many of these stocks had at one time very low price to sales ratios long before they became ten baggers.
We can see that some of these stocks have increased by ten fold.
Your probably wondering what in the world Im I talking about when I use the term price to sales ratio. And why in the world is this metric so important in determining whether a stock could turn into a ten bagger or not. Well its really not that complex.
I will try and put it in laymen terms so all of you investors out their can use this outstanding valuation metric to find that next big ten bagger.
Simply put the price to sales ratio is all of the shares of a companies stock that are issued and outstanding mutplied by the price. Simply stated. If a company does 1 billion in annual sales but it has a market cap of 100 million dollars than the price to sales ratio is ten to one. In other words the market is valuing a company that does 1 billion dollars in annual sales at just 100 million dollars. But what does this mean. It means everything if you are a classic value investor.
Here is a perfect example of why the price to sales ratio is so very important if you are a value invest in stocks. If our 1 billion dollar company is breaking even that is they are not making a profit nor losing money. Lets say the company has 250 millon dollars in long term debt and 80 million dollars in cash. We will say they are in the food business they make a wide aray of food products. Maybe the company did a buyout of another company a few years ago that did not work out as well as expected. So thats why the company is having trouble making a profit but things now seem to be moving in the right direction. If I purchase shares in the company for say 10 dollars. And over a five year period the company improves their earnings performance to the point where their now earning say 60 million dollars on sales of one billion two hundred million dollars. Thats a profit margain of 5%. If the stock were to now trade at twenty times earnings that would now mean that the price of the stock would be at 120 dollars a share or another way to put it the marketcap is now one billion two hundred million instead of 100 million.
The problem for me is not that this investment method is not effective it works great. I purchased seaboard stock back in 2000. I think it was for 190 dollars a share around that. I following the exact method I describe above. I sold my shares about five years later for 2500 dollars yes thats correct 2500 dollars or more than twelve times what I paid for the shares. Seaboard was profitable when I bought it and profitable when I sold it. The stock was just a great undervalued stock that was overlooked by investors.
Like I was saying before the problem is not with this investment method. Its that stocks like seaboard are very rare indeed theirs just not a whole lot of quality companies out their selling a very low price to sales ratios. Another issue that I have been having is when a company of decent quality trades at a very low price to sales ratio its not long before a private equity firm or the family of a family owned company takes notice and usually makes a low bid for the shares and takes the company private preventing me from realizing the enormous gains that mght have been possible had I not been forced to sell my shares out to a party that was making a very unfairly low offer for the shares of the company.
Another thing to keep in mind when it comes to value stocks that have a low price to sales ratio that could give the buyer a tremendous advantage is this.
I mentioned earlier that are food company had 80 million dollars of cash on their balance sheet now if the company choose to they could buy back a large chunk of their stock maybe 30 million dollars worth of the shares outstanding it would only cost them 30 million dollars they still would have 50 million dollars of cash left on their balance sheet. This means that under the positive earnings outlook for the company the stock price could even be much higher than 120 dollars a share. If the company were to retire a large percentage of their exsisting shares in a stock buyback.