Finding the Next Big Stock

It's a question that haunts investors: "How did I let that stock get away?"

We all have our own story. Many times, the stock was sitting right under our noses, and we talked ourselves out of making an investment. Such mistakes can be discouraging, to say the least.

The important thing is not to give up searching for the next big stock. That's where Motley Fool CAPS can help. Our new stock screener, combined with the opinions of more than 105,000 investors participating in CAPS, can help you whittle down the list of potential winners.

It's a simple equation
In the short term, the market is unpredictable. In the long run, however, the market rewards companies that:

  • Consistently increase shareholder value.
  • Grow more quickly than their peers do.

For example, in 1972, Wal-Mart was a tiny retailer with 51 stores in five states. It had plenty of room to grow, and over the next five years, Wal-Mart began to show signs that it was going to be a major player:

Year

1972

1973

1974

1975

1976

Number of stores

51

64

78

104

125

Return on equity

27.0%

18.5%

20.0%

17.2%

23.7%

Source: Wal-Mart annual reports.

Wal-Mart's promise was difficult to miss. Not only was it expanding rapidly, but it was also generating solid returns on investors' equity year after year. Over the next 32 years, Wal-Mart sustained that performance in its business and generated 25% annualized returns for investors -- enough to turn a $1,000 investment in early 1976 into more than $1.2 million today.

So let's try it
Using the CAPS screener, I searched for highly rated small companies (less than $1 billion) that possess traits similar to what Wal-Mart had in its youth:

  • Return on equity greater than 15%.
  • Insider ownership greater than 10%.
  • Three-year annual earnings growth greater than 15%.

Here are a few of the results:

Company

CAPS Rating (Out of 5)

Sector

Under Armour (NYSE: UA  )

***

Consumer goods

Zumiez (Nasdaq: ZUMZ  )

****

Consumer goods

Super Micro (Nasdaq: SMCI  )

****

Technology

LSB Industries (AMEX: LXU  )

*****

Industrial goods

Interactive Intelligence (Nasdaq: ININ  )

****

Technology

Data from Motley Fool CAPS as of May 19.

These stocks appear to be promising, but this is not a list of formal recommendations. Instead, use it as a starting point for further research.

Click-clack to pitter-pat?
Seeing activewear renegade Under Armour among a list of small-cap stocks puts the company's struggles over the past year into stark perspective. As recently as last summer, it had a market cap well beyond $3 billion. Today, however, shares are about 50% off their 52-week highs.

But has all the pessimism been priced in?

CAPS investors sure think so. Fully 90% of the 1,670 players who have rated the stock think it will outperform the S&P 500 going forward.

Player LookMomBoogers sums up recent bullish sentiment: "I like the price here, I'll admit they have hit the skids of late but, I'm adding some to my port now. My good friend coaches HS football and the only gear the kids by is Under Armour, we'll see if this works out for the shoe line."

Yet the Under Armour bears remain vocal on the stock's CAPS page. One of these bears is morgan628, who seems skeptical about Under Armour's move into footwear:

Under Armour is pursuing performance training footwear and is heavily weighting the first half of the year with advertising the line. Considering that much of UA's growth can be attributed to advertising, I doubt they will limit brand exposure to their ad spending cap in the second half of the year.

Considering that [Adidas] and Nike are very strong players in the performance footwear market, I think UA's move away from its core business is risky at best. UA's ad campaign will have to be nothing less than stellar to gain a foothold in the above mentioned market. I have very strong doubts.

The case of Under Armour eerily reminds this Fool of what happened to Timberland (NYSE: TBL  ) in the mid-1990s. Back then, Timberland was the market's retail darling; its shares soared 170% in 1993 alone. But its ballooning inventory, increasing long-term debt, and reduced growth estimates eventually drove the market to question Timberland's prospects. As a result, Timberland shares fell 59% the following year, not unlike Under Armour's own recent tumble.

Timberland eventually recovered, but it took some time. Similarly, Under Armour has some work to do. Profiting from any potential turnaround here will likely require some patience from investors.

What do you think about Under Armour -- or any other stock, for that matter? Join the other 105,000 investors participating in Motley Fool CAPS today, and make your voice heard!

Zumiez is a Motley Fool Hidden Gems pick. Wal-Mart Stores is a Motley Fool Inside Value recommendation. Under Armour and Interactive Intelligence are Motley Fool Rule Breakers picks. The Fool owns shares of Under Armour. Try any of our Foolish newsletters today, free for 30 days.

Fool contributor Todd Wenning believes there is a positive correlation between the popularity of The Hills on MTV and the dumbing-down of America. He does not own shares of any other company mentioned. The Fool's disclosure policy keeps Fooldom running smoothly.


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