Massive Growth!

My apologies, but that's really how the fax read. It was a pitch for a penny stock. I'm not going to mention the name, because I don't see this company as legit. Plus, I don't want to offer the comfort of publicity to the spammers that sent this crap to me.

But let's go through the basic pitch anyway. It's instructive to see what spammers are pushing and how so you'll know what to avoid in your own investing.

The hook
Every piece of stock spam you receive is going to try to establish credibility immediately. Here's how the huckster pitching me did it:

HYPE INC. is a unique INVESTMENT OPPORTUNITY that is positioned for significant share price appreciation, with realistic financial forecasts projecting rapid revenue growth and high-net profitability.

We are able to identify stocks just before Wall Street gets word of them in turn enabling our members to make significant profit gains. Our last recommendation on GARBAGE INC. back in December 2005 helped our subscribers realize a gain of over 450% in their portfolio.

Here are the clues this is a scam:

  • There's no such thing as "high-net profitability."
  • Wall Street may ignore some stocks, but it certainly is not unaware of them.
  • That 450% return looks great. But the same stock they reference has lost more than 25% of its value recently, and there's no record of this so-called membership firm or its scorecard anywhere on the Web. You're taking this "gain" entirely on faith.

The "proof"
The best pitches also include some sort of proof that attempts to show the firm is sustainable. Here's how it went in the fax to me:

FINANCIAL PROJECTIONS

HYPE INC. is positioned for explosive growth in the coming five years and beyond. Our realistic assumptions are based on selling 100 franchises in 2006, 300 in 2007, 600 in 2008, 1,000 in 2009, and 1,500 in 2010. This would be similar to the historic growth figures for CREDIBLE COMPANY. Under this scenario, total revenue would increase from $2.7 million in 2006 to $59.5 million in 2010.

The clue that this is a scam: 85% compound annual growth over five years is rare. Even Starbucks, a superior growth story, averaged just 65% annual revenue growth in its early stages.

The fine print
Of course, there's other flawed logic, but you get the point. Let's move on the fine print, where the scam is revealed:

Compensation: TRYING TO BILK YOU INC. shall be paid $182,000 for the marketing of this publication from a third-party affiliate of HYPE INC. There is an apparent conflict of interest since third party may sell stock in the open market. [emphasis mine]

Un-freaking-believable.

The reality
It's a sad truth that some people out there are trying like crazy to get you to buy into high-growth stories that make no sense. Sadder still is that these hucksters reflect really poorly on growth as a strategy. I know some investors who eschew growth entirely because of the spam they receive. Don't let that be you, Fool.

After all, these scams work because massive sales growth really can be a great indicator of outsized returns. But you don't need to go to the pink sheets to get it. Here's a list of seven firms that trade on major exchanges. Each grew revenue by more than 50% annually over the past five years:

Company

5-year sales CAGR

5-year total return

eBay (Nasdaq: EBAY  )

60.2%

334.6%

GSI Commerce (Nasdaq: GSIC  )

59.4%

447.8%

Intuitive Surgical (Nasdaq: ISRG  )

53.6%

1,097.0%

J2 Global Communications (Nasdaq: JCOM  )

59.5%

3,936.3%

Jarden (NYSE: JAH  )

54.9%

993.9%

Marvell Technology (Nasdaq: MRVL  )

63.3%

818.5%

Websense (Nasdaq: WBSN  )

53.5%

346.3%

Data provided by Capital IQ, a division of Standard & Poor's

For the record, the S&P 500 has returned a little more than 20% over the past five years (including dividends).

Break the rules, not your portfolio
But that's no surprise, right? Growth investors have trounced the market for decades. T. Rowe Price and Philip Fisher come to mind. And, to a lesser degree, David Gardner. His Rule Breaker style seeks legitimate businesses with sustainable advantages, talented and committed managers, and which serve growing legions of customers. That's why, over a 10-year period, the real-money Rule Breaker portfolio generated average returns in excess of 20% annually. And its successor, managed by David and his team at Motley Fool Rule Breakers, has identified four multibaggers in just 18 months, with another on the cusp as I write. Intuitive Surgical, one of the magnificent seven listed above, is one. Want to know the other three? A 30-day all-access pass will get you the answer. It's free and there's no obligation to buy.

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 Fool profile. eBay is a Stock Advisor recommendation. The Motley Fool has an ironclad disclosure policy.


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