Ever since you were a toddler, you’ve been told that breaking the rules is a bad thing. But in investing, rule breaking can be good. Very good.
At The Motley Fool, rule breaking means investing in the great companies of tomorrow — the ones that could lead you to awesome returns … before Wall Street catches on.
How do you identify a Rule Breaker stock? Well that’s the tricky part. It’s not just about growth rates and buzz.
Motley Fool Rule Breakers, our high-growth investing service, helps you find companies that are the most likely to sustain extraordinary growth over a long period of time. The Rule Breakers team looks at six specific criteria when identifying these “Rule Breakers”…
1. Top dog and first mover in an important, emerging industry
It isn’t hard to identify the top dog in a given industry. It’s the ones barking the loudest.
Rule Breakers are the companies that are creating new business models, disruptive technologies, and innovative marketing strategies. Naturally, they tend to have the highest market caps … and attract tons of media attention, too.
Examples? Think Starbucks in coffee, Facebook in social media, Amazon in e-commerce. None of these companies invented an industry — there were, in fact, coffee shops before Starbucks — but each was the first to exploit and dominate a niche within its industry. And each niche was clearly well-worth dominating.
2. Sustainable advantage gained through business momentum, patent protection, visionary leadership, or inept competitors
Strong companies attract competition. What really matters is how well a company can fend off its competitors — how wide its “moat” is (and how many alligators are in it).
The most promising businesses are the ones with the widest moats. They’re able to gain the upper hand over their competitors and then sustain it — whether through patent-protected trade secrets, high levels of capital investment, or superior leadership.
3. Strong past price appreciation
If Newton had been an investor, you would probably be learning a 4th Law of Motion …
A stock on the rise tends to remain on the rise unless an external force disrupts its path.
The best growth stocks often continue to rise — even after their share prices have shown impressive climbs — because the underlying companies are constantly growing. Businesses that sustain great earnings and cash flow growth tend to continuously gain new customers and investors, which translates to higher stock prices.
Of course, there’s no guarantee that this momentum is your ticket to high earnings, but when it’s coupled with other strong company fundamentals, there’s reason to be optimistic.
4. Good management and smart backing
Here at The Motley Fool, we think that this is the most important attribute of them all. After all, strong management makes for a strong company. A mediocre business with great management is always better than a great business with mediocre management!
How exactly do you judge the quality of a company’s managers? After all, it’s not like you can sit down and talk to each of them one-on-one. But you’d be surprised — you can learn a lot by listening in on conference calls, going to investor presentations, or browsing the Internet. It’s also useful to look at who’s backing the company — if the very best venture capital firms are behind it, maybe you should be, too.
5. Strong consumer appeal
We can’t overstate the power of a strong brand. Businesses with a strong consumer appeal tend to have a much easier time when it comes to sustaining high growth for the long term. After all, you learn to associate a brand with a particular experience. And when this experience is a good one, you’ll keep coming back for more.
Of course, some great companies work in specialty businesses that don’t have mass consumer appeal, and that’s OK. What’s important is that there’s a connection between the company and the people who matter. Say you’re looking at an esoteric software business — does it have a throng of loyal tech followers? If so, you know that the brand is successful.
6. Grossly overvalued according to the financial media
This might sound like an odd factor. Who wants to buy a stock that wise financial commentators say is way too expensive and poised for a tumble?
But in fact, many of our Rule Breakers have been deemed overvalued. And then they went on to double, triple, quadruple, or more in the following years! This “too expensive” label is often the result of stock analysts underestimating the power of a company to innovate, disrupt an industry, and sustain growth over a long period of time. So let the haters hate…
These 6 criteria aren’t guaranteed to point you to every winner, but they provide a framework for evaluating fast-growing companies and determining which ones are most likely to sustain this growth. If you need more help finding today’s hottest growth stocks, get started with a Rule Breakers membership today. Our team of analysts, led by Motley Fool co-founder David Gardner, will point you toward the growth stocks that are worth your attention.