Hot Stocks That Actually Go Up

Every one of us has tried to buy the next hot stock. Most of us have been burned in the process. But can it work?

Hot sometimes means really hot
BusinessWeek recently published its new Hot 100, a list of companies that it calls "strong, agile, and fiercely competitive." In other words, they're small-cap stocks with large-cap dreams. Not all will succeed, of course. And, to their credit, BusinessWeek writers have singled out notable recent losers from earlier lists, such as watch maker Fossil.

Still, there's a lot to like about the Hot 100 methodology. BusinessWeek screens thousands of small caps and picks the best based on a combination of sales and earnings growth and return on capital. Though arguably a little too broad -- I also look for substantial insider ownership and recent buying, for example -- the aim of finding growers strikes me as exceedingly Foolish.

That's why I'm not surprised that the top five growers from 2003 are, as a group, pummeling the market:

Company

May 9, 2003,
adjusted close

June 1, 2006,
closing price

Total return

Aeropostale (NYSE: ARO  )

$12.67

$26.63

110.2%

Chico's FAS (NYSE: CHS  )

$10.50

$30.70

192.4%

Odyssey Healthcare (Nasdaq: ODSY  )

$19.00

$16.83

(11.4%)

Corinthian Colleges (Nasdaq: COCO  )

$23.16

$13.98

(39.6%)

Shuffle Master (Nasdaq: SHFL  )

$10.67

$37.82

254.5%



With an equal investment across these stocks, you'd have more than doubled your money today. That easily bests the S&P 500's (still impressive) 37% return over the same period.

What makes a winner
Of course, you'd have done even better if you'd simply bought Shuffle Master -- the best performer of the bunch. But there was simply no way to separate the winners from the losers back then, right?

Don't be so sure. While it's true that Shuffle Master and Corinthian Colleges both had strong fundamental indicators and decent insider ownership, one trait separated them: competitive advantage within a wide market opportunity. While Corinthian has had to duke it out with a number of for-profit educators, including giant Apollo Group (Nasdaq: APOL  ) and its popular University of Phoenix, Shuffle Master was left to dominate money-losers such as Progressive Gaming.

It's simple: The hot small stocks that succeed -- and I mean really succeed -- have wide market opportunities.

The next hot stock?
So, which firm among the new Hot 100 appears most promising? I like American Science & Engineering (Nasdaq: ASEI  ) , which clocks in at No. 12 on BusinessWeek's latest list. Why? AS&E, which is an active Motley Fool Rule Breakers selection, has created a unique X-ray machine to increase security at borders and airports. And by "unique" I mean that the company's superior proprietary technology has little competition.

That may be why governments can't seem to get enough of the devices (sales were up 85% in the most recent quarter). But investors remain uninterested; they're more concerned with the latest earnings miss. (Never mind that analysts may have been too optimistic in their assumptions.) Although AS&E has traded down substantially since the beginning of May, this is a company that has grown its bottom line more than 100% annually over the past five years. And given its technology and the worldwide need for greater security, I see this trend continuing.

The term "Hot Stocks" may sound trite, or if you're a value investor, downright scary. But don't be afraid: There's a lot to like about fast growers as long as you can see the growth continuing. That's why world-changing companies like eBay never looked cheap, yet always offered great returns.

At The Motley Fool, we call these world-changing companies Rule Breakers, and our Rule Breakers research team is trained to find them before anyone else on Wall Street. To date, we've already discovered four multibaggers that have paced our portfolio to a 10 percentage point lead over the market. If you'd like to learn more about our ultimate growth service, click here for a free 30-day trial. There is no obligation to subscribe.

Fool contributor Tim Beyers only breaks the rules in his portfolio. Wimp. Tim didn't own shares in any of the companies in this story at the time of publication. Shuffle Master and eBay are Motley Fool Stock Advisor selections. The Motley Fool has an ironclad disclosure policy.


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