One of the most enduring of Hollywood legends concerns the story, perhaps somewhat apocryphal, of how Lana Turner was discovered while she was sitting at the soda fountain counter at Schwab's drugstore in Los Angeles. Apparently some Hollywood mogul saw her and decided she needed to be a movie star, and the rest is history. There are probably still--and likely will always be--legions of aspiring screen stars waiting tables and hoping to one day serve a plate of Foie gras to Steven Spielberg, who will immediately recognize that he has found the next Sandra Bullock or Tom Hanks. The dream of discovery, from either side of the epiphany, exerts a powerful pull on the imagination, just as much in the world of Wall Street as in the City of Angels. What investor does not dream of finding the next Apple or Amazon?
Of course, if I had found the secret formula for picking the next fortune-maker, I would be writing this post from a Tahitian beach or some other exotic locale, sipping on my afternoon pina colada (instead, it is a rather dreary February day in Memphis). What we can do here, however, is develop a road map for increasing the odds that such a wildly successful stock will end up in our portfolios. When I think about the people I know (or know of) who have made truly transformational fortunes (ten or even a hundred million dollars or more) through stock ownership, most had either a direct or family association with a company from the "ground floor." Think about the earliest investors in FedEx as just one example. Most of these people had the majority of their net worth in just the one company, and over many years the value of their stock increased as the company grew from its earliest beginnings into a major corporation. Right away, we need to recognize that this is not something we are likely to achieve, because the foundational investment principle we adhere to is based on having a diversified portfolio of stocks--we are not going to bet everything on one company. Our more modest aspiration is to uncover the occasional ten-bagger (a stock that will increase in value by a factor of 10 or more) that can help fund a child's or grandchild's education or provide for a more comfortable retirement.
If we are good at stock-picking, many of our stocks will be singles, doubles, and maybe a few triples.If we want to hit a genuine home run, then we need to follow Rule Number One, which is to "Think Small." I think that Apple (AAPL, $456) is a very compelling investment right now, and I wouldn't be surprised if it reached $600 per share over the next year (when looking at AAPL, I like to divide by 10--a $45 stock going to $60 is a 33% return, impressive but by no means unheard of). Apple will not be the next Apple, though, owing to the "law of large numbers." It is already the largest company in the world by market capitalization ($426 billion), so unless they are going to take over the entire world, it's not likely that the company would achieve a market cap of several trillion dollars. The place to go hunting for potential home runs is in the small cap sector, so we're talking about a market cap of less than $1 billion (mid caps are typically considered to have a market cap between $1 billion and $5 billion). For our purposes we don't want to be too rigid about limiting our selection universe, especially if we find an intriguing company that might be solidly in the mid-cap sector.
There are plenty of small publicly traded companies out there, so we want to focus on those whose business can be a true "game changer," a product or service that is revolutionary enough to provide years of exceptional growth. Let's look at some examples, but please keep in mind that I am not recommending that you buy any of these stocks (you may want to pursue additional research or discuss with your financial adviser). Westport Innovations (WPRT, $38, market cap $1.9 billion) makes engine and fuel system technologies that allow petroleum-based engines to run on natural gas. That's pretty exciting because the price of natural gas has fallen dramatically, making it a more attractive and cost efficient alternative to oil. If there is a long-term shift to gas engines, WPRT stands to have a bright and profitable future. AuthenTec (AUTH, $3.47, market cap $153 million) is a provider of security and identity management technologies, including fingerprint sensors, for computers and wireless devices. Their products stand to benefit from the growing concern about secure transactions and access to data. 3D Systems (DDD, $19, market cap $997 million) makes three-dimensional (stereolithography) printers, and this sounds like something straight out of science fiction. Their printers don't spew paper--they create/assemble objects. One day you may be able to "print out" the spare part you need for your washing machine. CVD Equipment (CVV, $14.50, market cap $86 million) is in the semiconductor business, with a focus on nanotechnology. CVD has been developing uses for a compound called graphene, which is a one-atom-thick layer of carbon that can supposedly conduct electricity 30 times faster than silicon. If all of this has your head spinning, just take a deep breath and try to remain calm. Most of all, don't bet the farm on anything.
It seems tautological to say so, but in order for something to be discovered, it first has to qualify as being undiscovered. There would be no legend about Lana Turner being discovered at that drugstore if she had already made a few movies by the time she plopped down at the soda fountain. The best way to gauge how undiscovered a stock might be is by the number of analysts following the company--the fewer, the better. AAPL, for example, is followed by some 42 different research analysts (at least there are 42 different recommendations on the stock, most of them "buys"). WPRT has 10 analyst recommendations, while DDD has five, AUTH has three, and CVV has just one. Even when I am not swinging for the fences, I like it when a company doesn't have too much Wall Street coverage. There's an old anecdote (it's not really a joke, because it's more insightful than funny) about a client who calls his broker one day when the market is up big to inquire about what might be causing the tremendous rally in stocks. The broker pauses for a moment before answering, then in a whisper says: "I can't say for sure, but we are hearing that there are more buyers than sellers." The client then replies, "You are a genius. I am so glad you are my broker." We like to think that our stocks go up because they are earning great profits, but the technical truth is that investors buy them because of their profits (and expectations of higher future profits), and it is this buying pressure that drives the stocks higher. What we, as investors, want from all of our stocks is that we have found some tremendous potential in them ahead of the crowd, and that as they deliver on that potential, the crowd will fall in behind us and bid the shares higher. If we want to claim the mantle of discovery, we may not have to be first, but we at least have to be very early.
Whether it's Hollywood or Wall Street, the excitement of discovery is pretty much the same. And it's still the stuff that dreams are made of.
Life is short. Get busy.
Jim
Disclosure/Disclaimer: My family members and/or I own shares of AAPL, WPRT, DDD, CVV, and AUTH. Individual stocks are mentioned here for the sole purpose of illustrating investment concepts, and nothing stated here should be construed as a specific recommendation to buy or sell any security.
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