You ought to be a momentum investor.
Why? All millionaire-maker stocks have momentum. They boast increasing rates of revenue growth. They display pricing power via expanding gross margins. They have a record of raising guidance.
That's right, Fool. I'm talking not about price momentum but business momentum.
But they're often connected. Consider Akamai Technologies (Nasdaq: AKAM ) . After suffering through rumors that competitors were ruining its core business, Akamai reported higher returns on capital and a new multi-year deal to deliver iTunes content. The stock subsequently surged more than 15%.
Business momentum, meet price momentum.
And consider this: Of the 304 stocks that produced positive returns last year, 63, or 21%, raised guidance. That is, they enjoyed business momentum. Surely you know some of them: Sequenom (Nasdaq: SQNM ) , Hot Topic (Nasdaq: HOTT ) , and Amgen (Nasdaq: AMGN ) , to name three.
The limits of business momentum
Higher guidance isn't always a perfect indicator of rising prices, of course. American Superconductor (Nasdaq: AMSC ) raised its target last summer yet still fell more than 40% during 2008, losing to the S&P 500.
What happened? Growth slowed and margins compressed. In other words, American Superconductor exceeded limited expectations for its business, but it wasn't growing as fast as it once had, and that slowing momentum affected the share price.
This is by no means to be a slight toward American Superconductor. To the contrary; it's a cautionary tale about growth investing and business momentum. You see, even though revenue growth fell from a triple-digit gain in 2007, American Superconductor still boosted sales more than 70% last year. Think about that -- you can grow 70% and still lose momentum.
The beauty of business momentum
So there are limits to what guidance can tell us. Independent of higher margins and accelerating revenue growth, strong guidance says, well, nothing. Combined, these three traits can create a powerful triumvirate.
Witness Potash Corp. (NYSE: POT ) , which repeatedly increased guidance from 2004 to 2008. Gross margin doubled and revenue growth more than quadrupled over the same period. The stock is up more than four-fold since, compared to a 40% loss for the S&P 500.
Think of business momentum as a hedge. When we're suffering through a bear market, like we are now, it's the top businesses -- the ones that have momentum -- that will protect and perhaps even grow your portfolio. Or so says history.
Where to find the next great momentum stock? I ran a screen for stocks that:
- Are worth at least $250 million in market value and listed on a major U.S. exchange.
- Achieved a positive return over the past year.
- Raised guidance at least once over the past year.
- Grew revenue by at least 15% annually over the past two years.
- Are expected to boost sales by at least 20% annually over the next two years.
Capital IQ returned 20 candidates, including Netflix (Nasdaq: NFLX ) and a pick for the March issue of our Motley Fool Rule Breakers investing service -- which is also one of the 10 best stocks of the past decade.
Color me unsurprised. A key tenet of the Rule Breaker philosophy as Fool co-founder and chief rebel David Gardner describes it is that winners tend to keep on winning. That's why he's unafraid to add a 10-year multibagger to the service's portfolio now, in the midst of a deep recession. The odds favor success.
Care to learn more about the process? Click here to take a 30-day free trial to Rule Breakers. Not only will you get access to all of the team's research but you'll also learn the name of that stock. And, as with all of our services, there's never an obligation to subscribe.
Fool contributor Tim Beyers owned shares of Akamai at the time of publication. He's also a member of the Motley Fool Rule Breakers team, which counts Akamai among its recommendations. Netflix is a Stock Advisor selection. The Motley Fool's disclosure policy has never lost momentum.