Searching for 40,000% Returns

I have a confession to make: I am not a wealthy man. Now, this information might be worrisome to some of you, since I work for a company that provides advice on how to maximize personal wealth. I do, however, have a good explanation for my relatively modest financial situation.

I spent most of my 20s without an income, languishing away in grad school. During my 30s, I earned a pittance teaching history to college students. Only recently did I leave academia for the private sector, motivated by such grandiose dreams as being able to afford my own home and send my kids to college. All things considered, I have only one major regret over the past 20 years or so: I didn't invest early enough in the great companies of our generation.

What's past is prologue
During the past 20 years, the American economy has experienced phenomenal growth, fueled by a technological revolution that has transformed the way we work, shop, and communicate.

From 1984 to 2003, GDP grew by 77%, and manufacturing productivity expanded by more than 100%. To see how far we've come, just have a look at an old Star Trek episode. What was supposed to look futuristic back in the 1960s now looks utterly ridiculous. My underpowered laptop appears far more useful than anything Captain Kirk had at his disposal to navigate the USS Enterprise.

Since the 1980s, as video gaming established its foothold in American culture, game developers such as Electronic Arts (NASDAQ:ERTS) capitalized on this growing market trend. Dell revolutionized the way personal computers are created and delivered, vaulting past stodgy giants such as Hewlett-Packard (NYSE:HPQ). Dynamic companies such as Gap (NYSE:GPS) responded to new economic trends and began selling familiar products in more profitable ways. Retailers like Abercrombie & Fitch (NYSE:ANF) effectively responded to fashion demands from their target demographics. Info-tech companies like QLogic (NASDAQ:QLGC) and Symantec emerged with improved methods for network management and Internet software.

All of the companies mentioned above broke the rules when they first appeared on the scene. Now, of course, long after the fact, conventional wisdom recognizes the genius of these companies.

So imagine what would have happened if I had plunked down $1,000 on each of these outstanding firms early on in their high-growth stages, or within months of their IPO.

Data from Yahoo! Finance.

Since this article first ran, Dell has been pummeled by the market (like everything of late). Even after declining from a 40,000% return, it's still up 21,756% for early investors! A paltry $1,000 investment in Dell back in 1988 would have yielded $218,560 today.

Wait just a minute ...
Now, some of you might object. It's surely unlikely that an investor would have been able to get in on the ground floor of all of these great companies. Perhaps you're right. Let's see what would happen if we delayed our investments in two of those companies by two years, which might have given us more time to monitor these high-growth businesses.

While my hypothetical returns in Dell and Electronic Arts would have declined considerably had I waited, I still wouldn't complain about those profits. So we see that the great companies are still available at reasonable valuations early in their growth stages.

Money for nothing ...
You might be thinking: I like those huge returns; how do I get some of those? OK, now for some reality. The purpose of looking at the returns of the great companies listed above is not to show that growth investing is an all-win situation. Far from it. The purpose of the illustration is to demonstrate how well great companies perform over a long period. If you can identify just one great company early, and then hold on for the long term, you can do pretty well for yourself.

Growth investing is highly volatile, and it will fray the nerves of those individuals with a low risk tolerance. That said, all investors should devote a portion of their portfolios to growth stocks. For those traveling in the fast lane, an allocation of 30% of their portfolios might make sense. More conservative types should allocate at least 5% in order to provide a little juice for their investments. I'm somewhere in between, so I devote about 15% of my portfolio to growth.

Willie Sutton and investing
Should I concentrate all of my growth allocation on computer and Internet stocks? No doubt, there are still great opportunities in these areas. In fact, there's a Motley Fool Rule Breakers selection I like that uses the Internet in an entirely creative way to deliver one of the most timeless products out there. But we also need to find new areas to trawl for great companies.

You might recall the familiar story about Willie Sutton. When asked why he robbed banks, old Willie replied, "Because that's where the money is." With Willie's advice in mind, focus on those sectors where the next great companies are likely to emerge.

Epiphany
The high-growth train of the 1980s and 1990s has already left the station, and some of us were left behind, muttering obscenities to ourselves on the platform. We have two choices facing us today in 2008. One option is to lament our bad fortune, admit that high-growth stocks demand too much hard work and more than a bit of luck, and then resign ourselves to index funds, hoping to eke out 7% per year over the next 20 years. The other option demands boldness and vision. It asks you to forget the past and plan for the future by joining in the search for the great companies of the next 20 years.

The novelist George Eliot once said that "it is never too late to become what you might have been." That quote inspires me to seek those investments in the future that I didn't in the past. If you think our dedicated Rule Breakers team can help you in a similar quest, why not take a risk-free trial for 30 days?

This article was originally published on Feb. 2, 2005. It has been updated.

John Reeves does not own any companies mentioned in this article. Gap, Dell, and Electronic Arts are Motley Fool Stock Advisor recommendations. Gap, Dell, and Symantec are Inside Value recommendations. The Motley Fool has a disclosure policy.