Big Stock Ideas for Big Profit

I'm going to warn you right away: The type of opportunities I'm about to tell you about may not be for you. They're only for a certain type of investor.

If you're the type of person who prefers to hit for average, click here for some good advice.

But if you're the type of person who prefers swinging for the fences, knowing there will be some painful strikeouts to go along with some glorious home runs, read on.

Big ideas for big profit
The biggest ideas and the biggest resulting profits, almost without exception, belong to entrepreneurs.

Guys like Microsoft's (Nasdaq: MSFT  ) Bill Gates and Apple's (Nasdaq: AAPL  ) Steve Jobs, who wanted to make computers accessible to the common man. Or someone like Steve Wynn, who is behind some of the most famous names on the Las Vegas Strip: Bellagio and The Mirage (both now owned by MGM Mirage) and Wynn and Encore (owned by his company Wynn (NYSE: WYNN  ) ).

The problem is that entrepreneurs also take the biggest risks. For every Gates, Jobs, and Wynn, there are hundreds of flameouts. The thousands of hours of work dedicated to one idea come to nothing.

A better way
One group found a way to circumvent the system a little. They're called venture capitalists (VCs). Instead of taking a big risk on one idea, VCs provide funding for a portfolio of ideas. By investing in multiple boom-or-bust companies, they mitigate their risk somewhat.

There are still many flameouts, but the investments that hit, hit big. So big that the savvy venture capitalists' winners more than make up for their losers -- earning above-market returns in the process. To give you a feel for the returns possible, the market's historically returned 8%-10% average annual returns; venture capitalists generally target 20%.

How we can profit
Perhaps because he's an entrepreneur, Motley Fool co-founder David Gardner loves the venture-capitalist mentality. In fact, it's his approach to investing in individual stocks -- he seeks out a portfolio of companies that have the potential to be the ultimate growth stock stories of tomorrow -- the next Microsofts, Apples, and Wynns.

Since there are inevitably plenty of losers to go along with the winners, though, this investing approach is tricky business. Even for those investors who can stomach it, David only recommends allocating a minority of your portfolio to this type of investing -- "anywhere from 5% to 30%, depending on time horizon and risk tolerance."

Identifying the winners
For those who want to hone their ability to separate tomorrow's runaway winners from tomorrow's bankruptcies, David has identified six signs of the next big disruptive growth stock:

  1. Top dog and first-mover in an important, emerging industry
  2. Sustainable advantage gained through business momentum, patent protection, visionary leadership, or inept competitors
  3. Strong past price appreciation
  4. Good management and smart backing
  5. Strong consumer appeal
  6. Proof that it is overvalued according to the financial media

Looking at this list, you may see one of the difficulties of these types of stocks. They're rarely cheap by traditional valuation metrics like P/E ratios.

In fact, No. 3 and No. 6 show that David actually prefers when there's evidence of overvaluation. It's counterintuitive (especially to value hounds like me who usually go for low-P/E plays), but truly disruptive growth stocks tend to stay expensive as their earnings growth continues to support the high trailing multiples.

David enjoys the cries of overvaluation from the financial media because it keeps some investors away -- the same investors who will eventually capitulate and pile in at higher prices. 

Some true disrupters
The danger is paying too much for a stock that's not a true disrupter. If the future growth story isn't there, it's just a loss waiting to happen.

To help you implement David Gardner's six points for spotting a true disrupter, here are three companies he's recommended, along with the status quo they are trying to disrupt:

Disrupter

Status Quo

What They Do

Intuitive Surgical (Nasdaq: ISRG  )

Traditional surgery

Robotic surgery

Under Armour (NYSE: UA  )

Nike (NYSE: NKE  )

Athletic apparel

VMWare (NYSE: VMW  )

Microsoft

Virtualization / Cloud computing

It's easy to see how cloud computing or the use of robots for surgery disrupts the status quo; I included Under Armour to remind you that disrupters don't necessarily have to be technology-based. Under Armour is doing it by building a brand.

There's a disconnect here, though. Microsoft, which I pointed to earlier as a prototypical disrupter, is now part of the status quo, fighting the advances of VMWare and others. This is the life cycle of a growth company ... at some point a successful disrupter blows apart the ecosystem so thoroughly that it becomes the entrenched Big Dog.

Thus, most investors correctly view Microsoft as a mature blue chip whose heady growth days are behind it.

Meanwhile, the other examples I cited -- Wynn and Apple -- are still generally seen as growth opportunities. Even in the face of a recession, Wynn added its Encore additions to its Wynn properties in both Vegas and Macau within the last year and a half; Apple continues to innovate with its iPhone and iPad franchises even as it's grown to be one of the five largest companies in the U.S. (by market cap).

Yet both are getting awfully close to status quo territory, if they aren't there already.

If you're interested in finding the next disrupters (companies like Intuitive Surgical, Under Armour, and VMWare), remember David Gardner's six signs for spotting one. For more of his advice and recommendations (including his Best Buys Now), you can check out his Rule Breakers newsletter free for 30 days. As you would expect, he's had some big winners and some big losers, but his picks have beaten the market by an average of 25 percentage points. Click here to join him.

Anand Chokkavelu owns shares of Intuitive Surgical and Microsoft. Under Armour is a Motley Fool Hidden Gems pick. Intuitive Surgical, Under Armour, and VMware are Rule Breakers recommendations. Microsoft is an Inside Value choice. Apple is a Stock Advisor pick. Motley Fool Options has recommended a diagonal call position on Microsoft. The Fool owns shares of Under Armour and has a disclosure policy.


Read/Post Comments (12) | Recommend This Article (77)

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 May 28, 2010, at 7:59 PM, davefor wrote:

    I have been watching VMWare for awhile. Virtualization is everywhere but Microsoft gives it away for FREE so VMWare will have to morph into something else or have a reason to pay for that which is free. Morphing is possible but risky, so I will continue to watch unless someone can present something concrete as to how they will not only succeed but thrive.

  • Report this Comment On May 28, 2010, at 9:36 PM, Darwood11 wrote:

    VMWare reminds me of Netscape.

  • Report this Comment On May 28, 2010, at 10:56 PM, RHinCT wrote:

    Responding a bit to davefor...

    If you need what VMWare provides beyond the included-in-the-box virtualization from Microsoft, you are running a large operation and the incremental cost of VMWare is not that big a deal. Also keep in mind that not all systems that need virtualization are running a Microsoft operating system.

  • Report this Comment On May 29, 2010, at 1:26 PM, masterN17 wrote:

    Bought VMW during the March 09 lows. Mad profits!

  • Report this Comment On June 01, 2010, at 11:15 AM, T00by wrote:

    @Davefor

    Microsoft does NOT give virtualization for free, you have to buy their premium Windows 2008 server product in order to get the functionality. On the other hand, VMware actually DOES give an enterprise version of their virtualization product away for free that is more functional and robust than the version you pay for from Microsoft.

    See for yourself:

    http://www.vmware.com/products/esxi/

    I wouldn't worry too much about VMware's ability to morph just yet.

  • Report this Comment On June 04, 2010, at 1:44 PM, mikecoursey wrote:

    @ emily1212

    Here is a better idea. Go LONG on BP stock.

  • Report this Comment On June 04, 2010, at 3:49 PM, thisislabor wrote:

    i was thinking long on bp too. but let me ask how can a company be both in an important sector and in a NEW sector?

    anything new would normally be too new to know if it is important yet right?

  • Report this Comment On June 05, 2010, at 6:07 PM, ddevitos wrote:

    Has anyone been following Banco Santander SDR's (STD) - the stock is down to $8.92 from a high of $17.70 and now has a 9.6% dividend - the bank remains a very profitable company but is being slammed because of the problems in the Euro Zone - Anyone have an opinion on this.

  • Report this Comment On June 06, 2010, at 4:19 PM, bmc007 wrote:

    Banco Santander is a very solid bank - conservative in a good way. You are correct - the current share price is very much in relation to the European situation and not all that much to do with BS itself. Worth picking up for the dividend and future growth GL.

  • Report this Comment On November 09, 2013, at 12:24 AM, RyanPeckyno wrote:

    Microsoft is in the midst of a lot of change. Steve Ballmer is going to get replaced here shortly and a lot will depend on the new MSFT CEO. Microsoft, which has its cash cow business (word, excel, etc.), could emerege as a disruptive, innovative company -- like it was years ago. It will be interesting to see who is the next CEO. Internal or external? Someone from Nokia? The Skype merger?

  • Report this Comment On November 09, 2013, at 12:24 AM, RyanPeckyno wrote:

    Good calls above on BP and SAN -- I own both of them.

  • Report this Comment On June 20, 2014, at 9:18 PM, NinaSerentsia wrote:

    fvpharma.com, ladies and gentlemen is a good investment ))

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