The Best Stock Idea I've Ever Seen Is No More

When Disney (NYSE: DIS  ) bought Marvel Entertainment for $4 billion in cash and stock last fall, it created the first 14-bagger in the history of our Motley Fool Stock Advisor service.

In the months since, some former Marvel investors (two thumbs up, pointed inward) are holding their Disney shares, content to profit from a meager dividend and an enhanced studio business. We're getting a good deal; Iron Man 2 has taken in more than $425 million worldwide as of this writing.

Buying and holding great businesses like Marvel and Disney is the simplest and lowest-risk way to produce multibagger returns. By "great," I'm referring to a certain set of attributes I'll get to in a minute. First, let's look back at what Marvel was and what it became.

A brief history lesson
Multibaggers are rare to begin with; 14-baggers are rarer still. Of the more than 2,400 stocks traded on U.S. exchanges that were worth at least $150 million in market cap on June 7, 2002, only 33 are up ten-fold or better since the day Fool co-founder David Gardner first recommended Marvel. Some of the more notable names:

Company

Return

Akamai Technologies (Nasdaq: AKAM  )

2,165.9%

LAN Airlines (NYSE: LFL  )

2,220.9%

America Movil (NYSE: AMX  )

916.3%

Sources: Capital IQ and Yahoo! Finance.

As stocks, these otherwise very different companies have something in common. They were all leaders in important, emerging businesses at the time David was betting on Marvel.

Akamai was delivering Web content for some of the Internet's biggest names as broadband was becoming more prevalent. LAN Airlines was positioning itself as a preferred air carrier for South America just as Brazil, Argentina, Peru, and others were earning their reputations as "emerging economies." And Carlos Slim Helu's America Movil was selling wireless telephony service to an increasingly mobile Latin American workforce.

Interestingly, each of these stock stories remains intact. Akamai is delivering high-definition video over the Web. South America is still home to some of the world's most promising emerging economies. And America Movil is on track to grow earnings by roughly 13% a year over the next five years.

Promised growth is what drew David to Marvel. He bet on the company because he foresaw a "portfolio of media properties" being leveraged in ways that would produce massive cash flow, yet he was in the minority in the weeks following the release of Spider-Man:

With a low-priced stock and total market capitalization of only about $170 million, Marvel Enterprises -- Spider-Man's daddy -- is today priced at the equivalent of a few weeks of the blockbuster film's box office receipts. (A box office of which Marvel, incidentally, gets an unspecified cut -- 5%, it is said -- and the same amount for eventual DVD sales, as well.)

I'm among the many who didn't listen to that sage advice. Instead, I picked on Marvel for using debt to buy back shares, and remained skeptical of the company's deal to self-finance films starring minor characters.

Tapping into Mighty Marvel's licensing machine
But then I dug deeper, poring through the text of its self-financing agreement and management's projections. What I found was a far less risky deal than I had expected. David's thesis began to make sense. Cash would flow through the financing facility as films were made, paying off production borrowings. Meanwhile, cash from licensing agreements would fund the rest of the business and pay off debt for share repurchases.

And this was big business. In 2009, Marvel earned more from licensing than Phillips-Van Heusen (NYSE: PVH  ) and CBS' (NYSE: CBS  ) consumer products group, reports License Global magazine.

To understand how big an accomplishment this is, consider that Phillips-Van Heusen's imprints accounted for $5 billion in revenue last year. CBS properties were responsible for $300 million in licensing sales over the same period.

Marvel had been a licensing machine for years, and by May 2007, was beginning to look like a no-lose proposition. I was in. Within six months, shares had fallen below my $27.25 purchase price. So I ran some more numbers and found that investors were pricing Marvel Studios as if it were worth less than zero.

By the close of January 2008 -- five-and-a-half years after David's first recommendation -- I made Marvel 20% of my portfolio. You know what happened next.

What the next great multibagger will look like
I'm happy to have collected such a large gain. But I'm also eager to move on. Like you, I want to find the next Marvel Entertainment, and I want to start right now. Ready?

When I bought Marvel, it possessed three traits that made it the best stock idea I had ever seen:

  • A consistent ability to produce high levels of cash flow.
  • High returns on capital.
  • Proven revenue growth.

A good screener can help you find these traits. I use the one supplied by Capital IQ to look for companies worth at least $250 million in market cap that trade on a major U.S. exchange and that have:

  • Generated a better-than-20% return on capital over the trailing 12 months.
  • Grown revenue by at least 20% annually over the past three years.
  • Produced no less than $100 million in cash from operations over the past year.

Only 15 companies passed my test. As above, you'll recognize some of the names. Research In Motion makes the list, as does lululemon athletica (Nasdaq: LULU  ) . The yoga-mom clothier has generated a 28% return on its available capital over the past year.

But the stock I like best of all is a nine-bagger, Motley Fool Stock Advisor pick that David first singled out in May 2004, yet still trades for less than its long-term estimated growth rate. Which stock is it? Click here to get full access to all of David's reports and the service's full scorecard of recommendations. A risk-free 30-day guest pass is yours for the asking.

This article was originally published Sept. 1, 2009. It has been updated.

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Fool contributor Tim Beyers owned shares of Disney at the time of publication. Disney is a Motley Fool Stock Advisor selection. Disney is also a Motley Fool Inside Value pick. Akamai is a Motley Fool Rule Breakers recommendation. America Movil is a Motley Fool Global Gains pick. The Motley Fool has a disclosure policy.


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