The search for the next ultimate growth stock sometimes takes us down long, strange, windy roads. Other times it's as straightforward as Mom and apple pie. Today we're going down the latter path, sticking with the basics to cover what many consider to be the screen for finding Rule Breaking stocks: sales growth.
Obviously, I'm not talking about plain-vanilla sales growth. I'm talking about outrageous sales growth -- the kind of growth that boasts a deep voice and pumps iron at Muscle Beach.
Get big -- fast!
Rule Breaking businesses, you see, tend to grow really fast when their convention-busting products hit the market. Think of Apple (Nasdaq: AAPL ) and the iPod. Or Pixar and its spectacularly successful films, which have all but redefined what we expect from animated stories. Each has seen massive revenue growth and, as a result, has provided investors with spectacular stock market returns.
So when our team of analysts embarks on the search for new Rule Breakers, we usually start with companies that have generated in excess of 75% average sales growth over the past three years. There are several tools that will help you reveal candidates that meet this criterion. Here at Fool HQ we tend to use Capital IQ, a highly useful product that allows you to screen for almost anything. (Seriously, we've tried.)
Capital IQ found 65 firms that met our criteria this go-round. Some were frighteningly high, such as Storm Cat Energy (AMEX: SCU ) at -- wait for it -- 2,395.2%. Others barely made the cut, such as Cathay Merchant Group (AMEX: CMQ ) , with 100.0%. But three really stood out:
1. Headwaters (NYSE: HW )
Three-year-revenue compound annual growth rate (CAGR): 120.6%
Have you ever invested in garbage? No, I'm not talking about that stock that stunk so bad you had to hold your nose every time you opened your brokerage statement. I'm talking about trash. Refuse. Discarded waste. If you had, your portfolio might smell a whole lot sweeter today.
Enter Headwaters. This relatively unknown small cap derives nearly all its revenue from the waste that occurs when coal is burned to create electricity. Specifically, it has three businesses that put coal crud to use in some form. First is a renewable energy unit that owns a unique bonding agent to make it easier to transport waste called "fly ash" to plants where it can be transformed into synthetic fuel (using a patented process created by Headwaters). Second is a business that collects fly ash and resells it. And, finally, Headwaters has a construction unit that makes building materials, including a cement substitute that uses coal waste to improve the durability of concrete.
I realize that Headwaters sounds like the worst kind of boring business. But the company's performance is far from boring. In addition to sales, earnings and cash flow have expanded rapidly because of a combination of acquisitions and organic growth. And the company's stock has soared as a result.
I'll admit it's tempting to wonder if the run is over, especially because the company depends on a federal tax credit for close to 25% of its revenue. But growth in other areas appears so promising that even executives are buying up the stock, including a purchase this week by CFO Scott Sorensen. If history proves anything, it's that insiders rarely buy garbage when it comes to stocks.
2. TurboChef Technologies (Nasdaq: OVEN )
Three-year-revenue CAGR: 132.9%
Next it's on to fast food. TurboChef is somewhat like Middleby (Nasdaq: MIDD ) in that it supplies ovens that can cook a pizza in threeminutes. That's a startling innovation, and the pitch has been resonating. A deal with Subway has proven lucrative, and there are reports that Starbucks has been testing its products. Our obsession with all things "quick-serve" and our ever-expanding waistlines also aid the investing case for TurboChef.
But this is also a one-product company that's burning cash. According to the most recent quarterly report, TurboChef burned more than $23.8 million in moola over the prior nine months. Over that same period, the company issued more than $57 million in stock to offset the burn rate. That can't continue forever. Which begs a question we often face with Rule Breakers: Will TurboChef's innovation generate enough cash on its own to fund the business indefinitely? If it does, Middleby-like returns could be in store. If not, look out below.
3. CompuCredit (Nasdaq: CCRT )
Three-year-revenue CAGR: 112.7%
CompuCredit, which originates credit and services credit card accounts, may be the most stable of our slate of candidates. Indeed, unlike TurboChef, it makes money (lots of it, in fact), and it boasts strong and improving margins. It also doesn't hurt that fellow Fool Rich Duprey publicly lamented selling his position in the stock too soon. (The shares are up more than 85% over the prior 52 weeks, according to Yahoo! Finance.)
Could we call this a classic Rule Breaker? Maybe. Unlike its massive competitors, CompuCredit has an entire business unit dedicated to unsecured microloans due on the customers' next payday. That may sound suspiciously like pawnbroking or even loan-sharking, but it isn't. To the contrary -- microlending has become big business in many parts of the world, and has even become a key lever for lifting some out of poverty.
But let's be clear: CompuCredit is a financier, not a charity. (Though it sometimes gives to charities through a shareholder-defined program.) It's highly likely that its microcredit business is frequented by as many gamblers and degenerates as it is those with genuine needs. Nonetheless, this isn't your average financier. And that, along with its prodigious growth, makes the stock at least worth a look.
Just the beginning
There are innumerable ways to scan the markets for ultimate growth stocks. I hope what's been laid bare here gives you a bit of a head start, should you choose to take on the work for yourself.
Fool co-founder David Gardner has said that the businesses breaking the rules are those that are altering the economics of their industries. Most "Faker Breakers" will claim as much in a bevy of press releases, but the companies to watch out for will prove their worth through massive revenue growth. If you're seeking multibagger returns for your portfolio, find those companies first.
And then don't look back.
Get the latest Rule Breaking Foolishness with these tidbits:
This article was originally published on Oct. 14, 2005. It has been updated.
High-tech. Biotech. Nanotech. Any tech. David Gardner and his merry band of Foolish analysts cover them all inMotley Fool Rule Breakers. So far, their picks are beating the market by more than 15 percentage points as of this writing. Get in on the action -- and catch up on the buy reports of all 28 official recommendations -- by taking a risk-free 30-day trial today. All you have to lose is the prospect of better returns.
Fool contributorTim Beyersonly breaks the rules in his portfolio. Wimp. Tim didn't own shares in any of the companies mentioned in this story at the time of publication. You can find out what is in his portfolio by checking Tim's Foolprofile. Middleby is a Motley Fool Hidden Gems recommendation. Pixar is a Motley Fool Stock Advisor recommendation. The Motley Fool has an ironcladdisclosure policy.