Where the Multibaggers Are

You might have heard that several members of the Rule Breakers stock-picking team visited Silicon Valley last week. Why go now, when analysts seem to be predicting the death of tech

Here's why: "The San Francisco Bay Area saw a 22% jump in overall venture investment with $3.17 billion invested in 195 [third-quarter] deals with much of the growth driven by record investments in health care and energy. This marks the highest investment total for the region since the first quarter of 2001."

That's from a press release issued by Dow Jones VentureSource, which tracks the venture capital industry. The message? Silicon Valley, which Google (Nasdaq: GOOG  ) , Oracle (Nasdaq: ORCL  ) , and Sun Microsystems (Nasdaq: JAVA  ) call home, is still ground zero for innovation. Only now, venture capitalists are looking more carefully at alternative energy and health care than they are at classic information technology.

Do I smell innovation stew?
So be it. We need breakthroughs in both areas, and there's no place in the United States better suited to innovation than Silicon Valley. The place simply reeks of brainpower, for which you can thank Berkeley and Stanford. Rival universities in, well, everything, they're also the yin and yang of tech business development. Exelixis (Nasdaq: EXEL  ) has Berkeley roots. Google, Sun, Yahoo! (Nasdaq: YHOO  ) , and dozens of others were hatched at Stanford.

Ivy Leaguers also deserve their due, of course. We know that Facebook came out of Harvard, for example. So did Microsoft, by way of legendary dropout Bill Gates. Akamai (Nasdaq: AKAM  ) , meanwhile, has roots at MIT. But you'd be hard pressed to find an area whose institutions combine intelligence, creativity, and capital as expertly as the Valley does.

A drive up Innovation Avenue
You'll find these institutions throughout the Bay Area, but Sand Hill Road, in Menlo Park, offers a confluence like no other. Innovation Avenue, as I call it, is a tree-lined megastreet that on the south side runs parallel to the Stanford Mall and, beyond that, the Stanford campus. The north side hides the deceptively modest offices of some of America's richest investors, including John Doerr of Kleiner Perkins Caulfield & Byers and Michael Moritz of Sequoia Capital.

Benchmark Capital's Bill Gurley, another successful longball investor who generously spent an hour talking through the state of tech with us, works from an office in the same area. Stanford may as well be recruiting ground for these three and their peers.

And think about this: Even as Goldman Sachs (NYSE: GS  ) agreed to a timely-though-usurious capital infusion from Buffett, small Bay Area bankers remain reasonably well positioned. The Wall Street Journal recently singled out San Francisco's Thomas Weisel Partners -- a tech specialist -- as a company that might prosper in a recovery. I agree; local access to Silicon Valley's finest is a massive advantage.

How to find the next great innovator
We rebels will go anywhere to find innovators. We're looking for companies that sport these sorts of characteristics:

  1. Clarity of purpose. Great companies can be summarized in a single sentence.
  2. Large markets. Buy where there's a billion to be made. At least.
  3. Rich customers. You don't need me to explain this, right?
  4. Focus. Simple products with obvious value are easy to sell.
  5. Painkillers. Great businesses solve a real problem facing consumers.
  6. Thinking differently. Inventive firms drive their competition nuts.
  7. Team DNA. Talent attracts talent, and talent usually produces excellent returns.
  8. Agility. Being first to new markets matters.
  9. Frugality. Great managers allocate capital only where they must.
  10. Inferno. Excellent businesses produce huge returns from even small doses of capital.

What you should know about this list is that it belongs to Sequoia; it's what the company calls the "Elements of Sustainable Companies."

Surely, great companies can be found everywhere. But if you look at our Rule Breakers scorecard -- and Sequoia's -- you'll see a concentration of Silicon Valley companies. History says that's where the returns are. After our meetings in the area -- 18 in all, with company management teams and venture capitalists alike -- we're convinced that's as true as ever. Want to find out more? You can get all of our notes from the trip by signing up for our free dispatches. To sign up, just click here and enter your email address.

Fool contributor Tim Beyers owned shares of Akamai, Oracle, and Google, as well as Google's 2010 LEAPs, at the time of publication. He's a member of the market-beating Rule Breakers team, which counts Akamai, Exelixis, and Google among its recommendations. Microsoft is an Inside Value recommendation. The Motley Fool owns shares of Exelixis. Its disclosure policy wishes Mr. Market would make up his freaking mind.


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