The Growth Stocks You Should Be Buying

We all know the legends of growth investing. But I submit that growth grabbers can learn as much from a single phrase from Warren Buffett -- the patron saint of value investing -- as they might from the writings of Lynch and Fisher. It is:

Be greedy when others are fearful.

I take this as a call to rebellion -- to invest where others won't. To zig as timid stock pickers zag. To order fish when the surrounding company chooses steak. And to buy stocks that cheapskates fear, such as China Medical Technologies (Nasdaq: CMED  ) , because they're the best value stocks available.

Let the haters be your friends
We pursue these misunderstood multibaggers in the making at Motley Fool Rule Breakers under the guidance of Fool co-founder David Gardner. You can follow our market-beating moves with a risk-free trial to the service.

Or, if you prefer to invest on your own, there's Motley Fool CAPS, a 100% free stock-picking community whose 110,000-plus participating investors rate stocks on a scale of one to five stars. More than 5,500 rated companies are in the database right now. Any of them could be a 10-bagger in the making.

To me, the best of these are high growers -- expected to improve earnings by 15% a year over the next five years -- which have also been heavily shorted. Companies with 5% or more of their available shares sold short can blast off like a rocket when the skeptics are proven wrong.

Let's have the list
Here is today's list of growth stocks that others fear:

Company

CAPS Rating
(5 max)

Short Interest

5-Year Growth Estimate

Shuffle Master (Nasdaq: SHFL  )

**

19.8%

23.3%

Affymetrix (Nasdaq: AFFX  )

**

16.8%

22.7%

Red Hat (NYSE: RHT  )

**

10.1%

21.8%

Netflix (Nasdaq: NFLX  )

**

50.3%

18.3%

Cheesecake Factory (Nasdaq: CAKE  )

**

18.7%

17.1%

Sources: Motley Fool CAPS; Yahoo! Finance; Capital IQ, a division of Standard & Poor's; and wsj.com.

Bear in mind that this isn't a list of recommendations. Instead, I offer these stocks as candidates for further research.

We have some interesting choices here. Netflix last made the list in November and still looks attractive to me. (Though less so after a bone-headed move to cut some customer profiles.)

Shuffle Master, on the other hand, is having difficulty, not helped by its chief financial officer resigning to "pursue other opportunities." (Rarely a bullish sign.)

A mighty green Red Hat
I prefer to invest in growth stories that attract insiders or top investors. Red Hat, named to this list twice before, qualifies. Growth guru Steve Wymer has been buying shares of the Linux leader for his Fidelity Growth Company (FDGRX) fund.

That's easy to understand. Red Hat attracts free cash flow like a stray dog attracts fleas -- more than $181 million over the trailing 12 months, more than twice its net income over the same period.

Foolish colleague Anders Bylund, reporting on the company's excellent first-quarter results, says the good times are likely to continue. Quoting from his recent take:

And if you doubt that the hackeriffic Linux platform is ready for a hard sell into the corporate space, consider that NYSE Euronext (NYSE: NYX  ) now runs its trading operations on Red Hat-powered machines. "Red Hat is as pervasive as water gear," said NYSE CIO Steve Rubinow, according to Red Hat's earnings call comments. "It is part and parcel of everything we do here from a computing standpoint." You can't ask for a stronger endorsement than that, especially since it comes from the traditional-minded Big Board boys at the heart of Wall Street.

CAPS All-Star databasehope13, a software developer, affirms this view in a pitch from May. Quoting:

Linux is a far superior OS system than Microsoft. Just look at the top ... super computers and find out what they're running (Linux, of course). Right now LAMP (Linux, Apache, MySQL, and PHP) is taking a nice chunk of the market and is project to do more of it. Anyway, not a lot of people [know] much about computers and how it works ... so this stock will be overlooked.

I'll add that, trading for 25.5 times its fast-growing cash flow per share, Red Hat strikes me as, at worst, reasonably priced.

But that's my take. I'm more interested in what you think. Would you buy Red Hat at today's prices? Let us know by signing up for CAPS today. It's 100% free to participate.

See you back here next week for five more misunderstood multibaggers in the making.

Netflix is a Motley Fool Stock Advisor selection. Affymetrix and NYSE Euronext are Rule Breakers recommendations. Try either of these market-beating services free for 30 days. There's no obligation to subscribe.

Tim Beyers, who is ranked 20,444 out of more than 110,000 participants in CAPS, is a regular contributor to Fool.com and a member of the Rule Breakers team. Tim didn't own shares in any of the companies mentioned in this article at the time of publication. The Motley Fool's disclosure policy is your portfolio's competitive advantage.


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