Will 2009's Hottest Stocks Be 2010's?

I set out to find the hottest stocks in the market right now.

I looked for the top performer in each sector, with only these restrictions: The company had to have a market cap of at least $200 million at the beginning of 2009 and sell on a major U.S. stock exchange.

You may be surprised that the much-ballyhooed shares of AIG (NYSE: AIG  ) and MGM Mirage (NYSE: MGM  ) weren't hot enough to make the list. Without further ado:

Industry

Company

2009 Return

Energy

InterOil Corp. (NYSE: IOC  )

459%

Materials

Teck Resources

611%

Industrials

Trina Solar (NYSE: TSL  )

481%

Consumer discretionary

TRW Automotive

563%

Consumer staples

Rite Aid (NYSE: RAD  )

387%

Health care

Human Genome Sciences

1,343%

Financials

XL Capital (NYSE: XL  )

406%

Information technology

RF Micro Devices

512%

Telecommunications services

Abovenet

349%

Utilities

AES (NYSE: AES  )

62%

Average

 

509%

S&P 500

 

23%

Sources: Capital IQ (a division of Standard and Poor's) and Yahoo! Finance.

Those are some blistering returns, to be sure. But they won't help us today -- unless their runs continue. The question remains: Will 2009's hottest stocks be 2010's?

Let's take a quick step back to see what happened with 2008's winners.

Industry

Company

2008 Return

2009 Return

Energy

Vaalco Energy

60%

(39%)

Materials

Eldorado Gold

66%

55%

Industrials

Beacon Roofing Supply

65%

15%

Consumer discretionary

Fuel Systems Solutions

129%

26%

Consumer staples

Prestige Brands

41%

(26%)

Health care

Sequenom

108%

(79%)

Financials

Crawford & Co.

250%

(73%)

Information technology

NCI

76%

(8%)

Telecommunications services

Shenandoah Telecommunications

19%

(26%)

Utilities

Laclede Group

42%

(25%)

Average

 

86%

(18%)

S&P 500

 

(38%)

23%

Sources: Capital IQ (a division of Standard and Poor's) and Yahoo! Finance.

All right, that's a lot of data to look at. Let's summarize it into three quick bullets:

  • None of 2008's big winners made 2009's list.
  • As a group, they got trounced by the market.
  • Only two of 10 beat the market; seven had negative returns.

I don't show you this data to try to extract any speculative rules from one year's worth of data. It's just a reminder that momentum eventually breaks. Jumping into the hottest thing around frequently looks good for a while. Until it doesn't.

The housing bubble taught us that on a grand scale.

The exception
There's a problem with ignoring 2009's hottest stocks, though. Sometimes a hot stock is an amazing growth stock story. And sometimes an amazing growth stock story looks just like a bubble.

Here's a quick example from recent history: There's an IPO and shares increase by 300% in less than two years ... despite a huge post-IPO market crash. If you refused to get in, you would have been somewhat vindicated the next year. The stock fell 3%. Then it went up another 500% in the following three-year period!

That was the Microsoft story from 1986 to 1991, well before its bubble-assisted growth in the late '90s.

And another exception
It can also be easy to ignore growth stocks because they frequently look expensive using measures like P/E ratios -- especially after big runs.

As their name suggests, growth stocks require years of high growth to justify those lofty valuations. When Motley Fool co-founder David Gardner recommended Intuitive Surgical in his Rule Breakers newsletter back in 2005, it had a P/E ratio of 71. However, its earnings have grown by so much that its P/E ratio is now lower after a 500% share price increase. Nice.

That's not always the case. More often than not, a stock with a P/E ratio of 71 is just plain overvalued.

Given that many of the hottest stocks I identified above have expensive P/E ratios, how do we tell the difference between an overvalued, bubblicious stock and a stock like Microsoft in 1986 or Intuitive Surgical in 2005?

I went back to David Gardner -- the guy who named his newsletter "Rule Breakers" -- for the answer. The stocks he's willing to pay up for are the ones that are "truly disruptive in their industries." In other words, they break the rules that their competitors cling to.

We all know how Microsoft disrupted the computer industry. Intuitive Surgical's business is replacing human surgeons with robots. I'd call that pretty darn disruptive as well.

Finding the true disrupters
Keep these examples of true disrupters in mind as you try to determine whether the hot stocks of this year will be the hot stocks of next year and beyond. Those that are priced for growth need to back it up with true rule breaking.

At this point, you're probably wondering whether any of 2009's hottest stocks are on David's list of true disrupters. The answer is no. Not yet, at least.

If they ever do make the cut for his Rule Breakers newsletter, though, note that the type of investing David does is not for the faint of heart. He's not going after bunts and singles. He's swinging for the fences. That means he makes his share of strikeouts. His philosophy is that the home runs more than make up for the strikeouts.

That's been the case so far. Since he started Rule Breakers in 2004, he's beaten the market by 19 percentage points. If you'd like to join him in stalking the long ball (and see all his recommendations), click here for a 30-day free trial.

This story was originally published Dec. 10, 2009. It has been updated. 

Anand Chokkavelu owns shares of Intuitive Surgical and Microsoft. Intuitive Surgical is a Motley Fool Rule Breakers pick. Microsoft is an Inside Value recommendation. Motley Fool Options has recommended a diagonal call on Microsoft. The Fool has a disclosure policy.


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