The Secret of Millionaire-Maker Stocks

We know from four years of corroborating research by my Foolish colleague Tim Hanson that the best stocks to buy and hold for the long term begin as ignored and obscure small caps.

But that can't be all there is. Any micro cap can be small and ignored. And not all well-managed, cash-conscious small caps make for multibagger returns. Just ask me about Secure Computing some time.

"There has to be something more to the very best of the best," I thought when studying this year's list. So I didn't stop there. I revisited the market's 10 best for the decades ending in 2005, 2006, and 2007.

What I found might help you to crush the market.

Here's what I found
Eight stocks made Tim's list more than once. Two earned three-peats. But only Hansen Natural (Nasdaq: HANS  ) , creator of a whole category of natural beverages, managed a four-peat.

And not just any four-peat. Hansen has topped Tim's list every year. The investor lucky enough to have bought $10,000 worth of this stock on Jan. 3, 1996, would have more than $3.6 million today.

What made Hansen so special? Growth. Sexy, beautiful, ginormous growth coupled with very high returns on invested capital:

Year

Revenue Growth

ROIC

Trailing 12 mos.

26.8%

37.5%

2007

49.3%

44.1%

2006

73.6%

56.4%

2005

93.5%

69.8%

2004

63.4%

45.5%

2003

19.9%

18.1%

2002

14.1%

10.4%

2001

12.5%

10.9%

2000

(0.8%)

16.5%

1999

34.2%

26.1%

Source: Capital IQ, a division of Standard & Poor's.

The secret of a millionaire-maker stock
Management's decision to enter the market for "functional beverages" like energy drinks in April 1997 may have been the catalyst. Interestingly, it wasn't the first to do so. Austria's Red Bull was an established leader in Europe and was winning customers here when Hansen entered.

But the U.S. was an emerging market for functionals. And Hansen CEO Rodney Sacks found an edge over Red Bull. His team focused on the taste, branding, and distribution of its flagship Monster Energy drink. Hansen differentiated itself from Red Bull and other competitors by blending its energy drinks with citrus-flavored fruit juice, introducing large cans with a hardcore look to appeal to younger customers, and utilizing unconventional promotional tactics like giving away free samples at convenience stores and sponsoring X Games athletes.

Buzz followed. Then, orders. Lots and lots of orders.

Hansen, in other words, helped shape a new multibillion-dollar category early in its development. Fool co-founder David Gardner has a name for firms like these: Rule Breakers.

I had my answer. The best stock of the decade, four years running, was more than just small, obscure, and ignored. It was also a rebel.

How to find today's best
I take three lessons from this narrative:

  1. High growth is best when coupled with high returns on capital.
  2. The very best small stocks are the ones creating new industries.
  3. You don't have to rush to buy the biggest winners.

Indeed, you could have waited until two years after Hansen's functionals rollout to buy and would still have enjoyed the largest multibagger of the past 10 years.

Today's investors have the same opportunity. Each of the following five small caps is like the Hansen of a decade ago -- growing fast and known for effective capital allocation:

Company

2-Yr. Revenue Growth

2-Yr. Est. Revenue Growth

ROIC

Almost Family (Nasdaq: AFAM  )

47.4%

95.1%

17.2%

LoopNet (Nasdaq: LOOP  )

39.1%

24.8%

17.5%

NIC (Nasdaq: EGOV  )

18.9%

32.5%

17.3%

ShengdaTech (Nasdaq: SDTH  )

50.3%

119.1%

18.1%

T-3 Energy Services (Nasdaq: TTES  )

34.2%

30.3%

15.8%

Source: Capital IQ, a division of Standard & Poor's.

Interestingly, LoopNet is already a pick of David's Motley Fool Rule Breakers service. I mention this because, in my screening for the next Hansen, Capital IQ found that 10 current Rule Breakers picks passed my tests. They had:

  • Listings on a major U.S. exchange.
  • A market cap greater than $150 million.
  • Historic revenue growth above 15% over the past 2 years.
  • Current ROIC above 15%.
  • Estimated revenue growth above 20% over the next 2 years.

The bad news? Satyam Computer (NYSE: SAY  ) also passed. Obviously, it takes more than a good screen to find rebel stocks. That's why David's team goes seven-deep. We depend on each other to go beyond the financials and study the likelihood of disruptive change occurring.

Care to learn more about the process? Click here for 30 days of free access to Rule Breakers -- you'll get unfettered access to all of our research, as well as our team's five top growth stocks for new money now.

Fool contributor Tim Beyers didn't own shares in any of the companies mentioned in this article at the time of publication. Tim is a member of the Rule Breakers team, which counts LoopNet among its recommendations. LoopNet is also a Motley Fool Hidden Gems pick. Satyam is a former Stock Advisor selection. The Motley Fool has a disclosure policy.


Read/Post Comments (4) | Recommend This Article (78)

Comments from our Foolish Readers

Help us keep this a respectfully Foolish area! This is a place for our readers to discuss, debate, and learn more about the Foolish investing topic you read about above. Help us keep it clean and safe. If you believe a comment is abusive or otherwise violates our Fool's Rules, please report it via the Report this Comment Report this Comment icon found on every comment.

  • Report this Comment On January 23, 2009, at 6:24 PM, cautiouswillie wrote:

    Question: Why choose AFAM and not AMED? Just curious.

  • Report this Comment On January 23, 2009, at 6:45 PM, TMFMileHigh wrote:

    Hello cautiouswillie,

    I can't speak to AMED specifically -- suppose I'll have to take a closer look -- but I like the accelerating growth at AFAM.

    Hope this helps and Foolish best,

    Tim (TMFMileHigh and @milehighfool on Twitter)

  • Report this Comment On February 02, 2009, at 12:04 AM, maverick2009 wrote:

    I'm a newbie so can you explain how investing $10,000 for HANS in 1996 will get you 3.6 million today? Is it through reinvesting and compounding? HANS does not give have any dividends.

  • Report this Comment On February 08, 2009, at 10:46 PM, GenXStocks wrote:

    I bought HANS prior to Monster. Reading that Hansen Natural drinks were gaining shelf space in California markets caused me to take notice. It was basically a penny stock. That is when the real opportunity for growth was available. Then Monster came along and the growth went to the moon.

    EESO is much like Hansen Environmental Enzyme Solutions has some pretty big announcements forthcoming. It has grown nearly 3000 percent since January 1. Yes, I said 3000 percent.

    Do your own research and you will find a company that is on the leading edge of green consumer retail products and green products for the industrial markets. This is just unreal what it is doing. I got lucky once with Hansen and have hit the jackpot again. Announcements with Wow Green Internation on the 15th of Feb. and an agreement in the works for a multi-million contract to market another product in South Korea is just the beginning.

    EESO

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