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 Motorola (NYSE: MOT ) and the RAZR mobile phone. Or Research In Motion (Nasdaq: RIMM ) and its spectacularly successful BlackBerry, which has become so popular that it's been nicknamed the "CrackBerry." 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 122 firms that met our criteria this go-round. Some were anomalies, such as Interoil (AMEX: IOC ) at -- wait for it -- 764.1%. (Always screen with a grain of salt.) Others barely made the cut, such as NutriSystem (Nasdaq: NTRI ) with 75.8%. But three really stood out:
1. R.H. Donnelley (NYSE: RHD )
Three-year-revenue compound annual growth rate: 125.2%
Can an old company be a Rule Breaker? Why not? The 164-year-old maker of the Yellow Pages directory, R.H. Donnelley, sure is showing some signs. Take its prodigious sales growth rate, for example. Fellow contributor Amanda Tyler reported last week that Donnelley's booming sales reversed its 2003 net loss in 2004, and a check of Yahoo! Finance shows the Street expecting $4.24 per stub in earnings for fiscal 2005 earnings. Nice.
How is it that a company whose products are likely lingering in the back of a cabinet in your laundry room doing so well? Cash flow, that's how. As Amanda points out, Donnelley sells ad space months before its directories are published and then collects fees monthly, long after the paper and ink are bought and paid for. That leverage has helped the company generate nearly $400 million in operating cash flow while posting a gross margin in excess of 50%, according to Yahoo! Finance.
Still, this is a mature industry. And paid search and online classifieds from the likes of Rule Breaker Universe member Craigslist aren't to be taken lightly. In fact, researcher Kelsey Group says that $3.8 billion of the Yellow Pages revenue will move online by 2008. But that's a fraction of the $15 billion BusinessWeek says small businesses spend on local advertising, mostly through Yellow Pages directories.
And Donnelley isn't sitting idle. Before the end of next year's first quarter, the company plans to merge with DexMedia (NYSE: DEX ) , creating the nation's third-largest directory provider with 19% market share. Dex also has a presence in online ad listings, which could help keep long-time customers loyal to its offerings.
2. BioMarin Pharmaceutical (Nasdaq: BMRN )
Three-year-revenue CAGR: 123.1%
Rule Breakers biotech analyst Charly Travers made BioMarin, a biopharmaceutical company that specializes in treatments for diseases too small for the major pharma firms, his pick for Stocks 2005, last year's Foolish stock annual. And it's paid off: BioMarin's shares are up more than 130% over the trailing 12 months, and they are still heading north.
Can it continue? CEO Jean-Jacques Bienaime seems to think so. Since September, he's spent more than $90,000 acquiring shares in the company, according to Form 4 Oracle. The latest purchase came just one week ago. That's a bullish sign.
3. SafeNet (Nasdaq: SFNT )
Three-year-revenue CAGR: 111.3%
SafeNet, which secures digital communications of all sorts, may be the most attractive of our candidates in terms of pure valuation. Indeed, a check of Yahoo! Finance shows the stock trades for a little more than 17.4 times next year's earnings. Before you shrug that off, consider the Street's expectations are for 30% growth in income during 2006. And, on average, analysts expect the company to boost earnings by 20% annually over the next five years. That smells remarkably cheap to me, especially for a business operating at ground zero in the white-hot information security market.
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.
This article was originally published on October 14, 2005. It has been updated.
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Fool contributor Tim Beyers only 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 profile. The Motley Fool has an ironclad disclosure policy.