Why Swinging for the Fences Pays Off

Investors in the stock market constantly strive to find the right balance between a stock's potential rewards and the risk of losing principal. Yet those who prefer to stay on the conservative side of the risk-reward spectrum are missing out on an investing strategy that can be hugely profitable if you're able to separate the hype from true fundamental potential for massive growth.

Obviously, that's easier said than done. Moreover, many experienced investors, including superinvestor Warren Buffett, argue that it's not worth the risk to put your hard-earned investment capital in real jeopardy, preferring instead to put "never losing money" as the top-priority rule to follow in investing. Nevertheless, if you work hard, you can focus in on some important characteristics that will boost your chances of finding a long-term winner. Let's look at a few of those characteristics now.

1. The chance to dominate an industry.
Sometimes, companies come along that have truly innovative ideas that are extremely difficult to copy. When such a company manages to successfully establish a moat that discourages competing innovators from trying to enter the industry, it can last for years and give the company a chance to go a long way on its own terms.

One great example is Intuitive Surgical (NASDAQ: ISRG  ) , which has revolutionized the medical field with its robotic surgical equipment. With traditional medical-equipment makers largely staying out of Intuitive Surgical's way, the company has posted huge growth over the past eight years and rewarded those investors who stuck with it throughout. Moreover, even as MAKO Surgical (UNKNOWN: MAKO.DL  ) and other upstart device-makers have tried to enter the space, they've given due deference to Intuitive Surgical, suggesting that it should enjoy quite a few more years of success in exploiting its newly created industry.

2. When high growth meets great value.
Most of the time, high-growth companies are renowned for having ludicrous valuations. But every once in a while, you get an opportunity to jump into a growth stock at a bargain price. If you're aware of a company's potential before you decide to invest, then you can look for entry points that maximize your chances of eventual gains.

As an example, look at cloud-computing company Rackspace Hosting (NYSE: RAX  ) . Just after its 2008 IPO, the stock market collapsed, and the newly public company's share price plunged along with it. Yet what people forgot was that since the IPO had done its job by raising much-needed capital for the company, Rackspace had the ability to weather the storm. Those who bought the shares at half-off in early 2009 have seen their investment jump 15-fold.

3. When solid management is on your side.
Investing is hard enough without having your own company's management working against you. With numerous scandals in recent years involving apparent conflicts of interest, such as the long set of travails between Chesapeake Energy (NYSE: CHK  ) and CEO Aubrey McClendon, smart investors learned a long time ago to avoid those problems.

Companies with leaders who maintain substantial ownership stakes -- preferably obtained by being a founder or early investor in the company -- offer some of the best chances for long-term growth. Starbucks (NASDAQ: SBUX  ) is a great example, given the way the stock has responded to the return of CEO Howard Schultz. Schultz wasn't a founder of Starbucks, but he ended up buying the retail unit of the company from its original owners in the mid-1980s. Since then, the company has taken off, and after an eight-year-long break from the CEO role, Schultz has sent the stock soaring again since his 2008 return.

Take a swing
Obviously, using these characteristics won't produce winners every time. Sometimes, bad things happen to great companies. But what's important is to maximize your chances of finding great performers that will make up for the inevitable losses along the way. As long as you find your fair share of blockbuster stocks, you'll end up ahead.

To get some smart ideas of high-growth stocks with superstar potential, look no further than Motley Fool co-founder David Gardner's Supernova service. David's picks of high-flying innovative companies have trounced the market, and for a limited time, you can get an inside view of David's thought process. Just click here and get a personal tour of Supernova today.

Tune in every Monday and Wednesday for Dan's columns on retirement, investing, and personal finance. You can follow him on Twitter @DanCaplinger.


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