Founding Fool David Gardner has made a career by bucking conventional wisdom with his rule-breaker philosophy of stock selection. David finds companies that the market considers overvalued, but which enjoy game-changing advantages over their peers.
Luckily for us, he's laid out six signs of the perfect rule-breaker stock:
- A top dog and first mover in an important, emerging industry.
- Sustainable advantage gained through business momentum, patent protection, visionary leadership, or inept competitors.
- Strong past price appreciation.
- Good management and smart backing.
- Strong consumer appeal.
- A documented history of being viewed as overvalued.
Talk about a needle in a haystack
While most of these traits are qualitative in nature, two of them could be considered quantitative. This can help us mere mortals get started by setting up a screen to winnow out clear non-rule breakers.
We can find strong past price appreciation by screening for stocks that are up at least 100% over the past year. To zero in on stocks considered overvalued, I looked for one-star stocks as rated by CAPS, as well as for companies with a P/E greater than 20. One-star stocks are clearly out of favor in our Foolish community, and many prudent investors would resist paying for a stock that trades at 20 times its earnings.
When I ran the screen, I got seven companies that weren't already rule breakers, and which had a market cap of more than $200 million:
|
Company |
Market Cap |
P/E |
52-Week |
What It Does |
|---|---|---|---|---|
|
Molycorp |
$4.4 billion |
191 |
181% |
Production of rare earth oxides |
|
ZAGG |
$420 million |
27 |
295% |
Protective coverings and accessories |
|
Shutterfly |
$1.72 billion |
95 |
109% |
e-Photo sharing |
|
athenahealth |
$1.97 billion |
100 |
103% |
Health-care-related data management |
|
Alto Palermo |
$580 million |
20 |
102% |
Shopping centers in Argentina |
|
Valhi |
$6.68 billion |
91 |
218% |
Chemicals, waste management, and component products |
|
Keynote Systems |
$395 million |
31 |
129% |
Cloud monitoring |
Source: Motley Fool CAPS, Yahoo! Finance.
Now we can use the rest of David's qualitative criteria to narrow down our field:
1. Top dog and first mover in an important, emerging industry
I immediately eliminated one of our companies. Valhi is neither a top dog nor in an important, emerging field. Its component products division sells things like desk drawers and vending machines. While products like this are important, they are not indicative of a rule breaker.
2. Sustainable advantage gained through business momentum, patent protection, visionary leadership, or inept competitors.
Molycorp is next on the chopping block. Though rare earth oxides are in demand right now, their continuing popularity will almost certainly wane; and with more competitors entering the fray from outside of China, any competitive advantage the company has could soon be coming to an end.
3. Good management and smart backing
This is a more difficult characteristic to judge quickly. For brevity's sake (before you make a final decision, you'll want to dig deeper), I looked at whether the founders still play a role in the company they started.
Our work becomes even clearer here, as three more companies are eliminated. Keynote Systems founders Jim Barrick and Andy Popell are nowhere to be found on the management team or board of directors. Shutterfly founder Jim Clark left the company in 2007; and Alto Palermo was founded back before 1900!
ZAGG's Robert Pedersen II is still on as CEO, and athenahealth's Jonathan Bush serves as CEO for the company he founded as well.
4. Strong consumer appeal
Both of these companies pass this test. The everyday electronic devices we rely on to organize our lives are growing smaller and smaller. This will no doubt continue, and we will be looking for more and more ways to protect these devices -- which ZAGG gladly provides.
athenahealth, on the other hand, provides the type of data management that is sorely needed in the medical profession. As the field's bookkeepers enter the 21st century, the consolidation of medical records into digital databases will be paramount.
That leaves us with two
At the very least, these two companies deserve a spot on your watchlist. ZAGG saw earnings nearly triple in 2010, and analysts are expecting 45% growth in 2012. If the company is able to deliver on that, today's P/E of 27 looks more than fair.
athenahealth, on the other hand, saw its earnings grow a more modest 37% in 2010, while analysts expect it to continue to the tune of 36% in 2012.
Going forward
The numbers I chose to use in my screen are by no means absolute. I used them as a starting point to turn up ideas for my search. I encourage you to jump on our screener and input slightly different numbers, dig into some of the companies that pop up, and share your findings below in the comments section.
If you'd like one more rule-breaking idea for your watchlist, I encourage you to check out The Motley Fool's latest special free report: "The Hottest IPO of 2011." Inside, you'll find out about a company that has the potential to give you the same type of results than past home run investments have given long-term shareholders. The report is yours today, absolutely free!
