This Stock Could Make You Rich

History proves that, while low-priced businesses can make for good returns, reasonably priced great businesses can make you rich.

By "great businesses," I mean those that are growing fast in important industries. These are the millionaire makers, emerging multibaggers that dour analysts often overprice, but which produce massive returns on invested capital. Some winners that you might recognize:

Company

Recent Price

5-Year Revenue Growth

ROIC

5-Year Return

China Mobile (NYSE: CHL  )

$42.79

20.9%

21.8%

186.2%

Hess (NYSE: HES  )

$58.37

23.5%

21.5%

181.9%

Precision Castparts (NYSE: PCP  )

$51.62

31.8%

22.0%

141.6%

Sources: Motley Fool CAPS, Yahoo! Finance.

Outsized growth is what made investors in these stocks rich. These stocks were worth paying for, as the best almost always are -- high price-to-earnings multiples be damned.

We've always placed far too much faith in the shorthand of multiples. We don't recognize that a stock trading for more than 100 times earnings can be cheap, as Frontier Oil (NYSE: FTO  ) was in 2004, before it tripled. And we forget that Southwestern Energy (NYSE: SWN  ) , one of the 10 best stocks of the past decade, traded for as much as 23 times normalized earnings in 1999 and 80 times earnings in 2005.

Why? Of the more than 200 stocks listed on major U.S. exchanges that recorded a positive return last year, 48 entered the year trading for more than 30 times earnings, including Strayer Education (Nasdaq: STRA  ) .

What's more, Foolish co-founder David Gardner frequently selects great businesses at reasonable prices for our Motley Fool Rule Breakers service and for his Motley Fool CAPS portfolio. CAPS is a 130,000-person stock-picking community; David's picks rank him in the top 2% of investors there.

Hunting for the next millionaire maker
So if paying up for growth works, why not do it more often? I suppose because doing so poses risks. Overpriced growers can fall faster than their (ahem) "cheaper" peers. Plus, betting on growth alone is dangerous -- any company can enjoy a short burst of unexpected success.

We want to pay up for businesses that are positioned for long-term growth. Firms that (a) already have a history of high growth, (b) are expected to maintain that pace for at least the next two years, and (c) produce above-average returns on capital.

I ran a screen at Capital IQ that returned 74 potential winners. My favorite on the list is two-time Rule Breakers recommendation Baidu.com (Nasdaq: BIDU  ) , which has a big following in our CAPS community:

Metric

Baidu

CAPS stars (5 max)

***

Total ratings

3479

Percent Bulls

87.9%

Percent Bears

12.1%

Bullish pitches

477 of 583

Data current as of March 11, 2009.

Lately, it's been tough to be a Baidu bull. Growth has been decelerating, thanks in part to an advertising scandal that first surfaced in November. Shares of Baidu are down close to 7% since.

Yet my friend Rick Munarriz, aka TMFBreakerRick, who recommended the stock for Rule Breakers, makes a good point in reporting on Baidu's fourth-quarter results last month:  

The near term can certainly get bumpy, but Baidu is attractively priced these days. It is now fetching less than 30 times trailing earnings, and even less if you back out the roughly $11.20 in cash equivalents on the company's balance sheet.

Adds CAPS All-Star Gaugamela in a pitch from earlier this week, "The dominant search engine in China, they're doing to [Google] what Google is doing to everyone else in the US. They have had some issues in the short-term, but this one is going to continue to rise over the long-term."

Do you agree? Disagree? Let us know by signing up for CAPS today. It's 100% free to participate.

See you back here in two weeks with another potential millionaire maker. Fool on!

Fool contributor Tim Beyers also contributes to the market-beating Rule Breakers service. Precision Castparts is a Stock Advisor selection. Baidu and Google are Rule Breakers recommendations.

Tim had stock and options positions in Google at the time of publication. Check out his portfolio holdings and Foolish writings, or connect with him on Twitter as @milehighfool. The Motley Fool is also on Twitter as @TheMotleyFool. Its disclosure policy has been living richly for the past 15 years.


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