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In 2006, I took a small amount of money from my bank account and bought some shares of Chipotle Mexican Grill (NYSE: CMG ) .
I wish I would have pawned all my worldly possessions along with those of my friends and family. The stock gained nearly 10 times its original value in just six years, climbing from about $45 to a peak of $440, before stumbling after its recent earnings report.
When I bought Chipotle, I didn't do any thorough financial analysis or even look at its P/E ratio, but I knew it was a great company, having visited their stores several times, and I knew it had just IPO'd so it seemed like a great time to buy. Going to college in Colorado, Chipotle's home state, gave me an advantage over other investors as I had early access and awareness of the company as well as the ability to see its popularity among my classmates, who raved about it. It seemed clear to me that this company was bound for success.
Recalling that experience, I decided to look back and see what lessons I could learn as I search for the next 10-bagger. The following are three key factors that I think investors should look for.
1. Mass appeal
Peter Lynch famously encouraged investors to "buy what you know" -- whether that knowledge is geographical, job-related, or something else -- as this is one of the best ways to find an advantage over the market. Simply paying attention to what products people are raving about and what companies are just better than the competition can be one of the first hints of a multibagger.
For example, I don't see a lot of corporate logos on car bumpers, but I've noticed that Apple (Nasdaq: AAPL ) and lululemon athletica (Nasdaq: LULU ) have gained legions of devotees based on this unscientific survey. It's no surprise, then, that their shares have gone through the roof. Lululemon is up more than 30 times from its bottom after the financial crisis, and though Apple's been around since the '70s, shares of the company could still be had for $7 back in 2003, when the iPod was first gaining popularity. While it may be have impossible to extrapolate the iPhone and the iPad and the remarkable success that would come with them from just the iPod, it was clear that Apple had a hugely popular, revolutionary product on its hands. This was no longer the same old second-place computer maker from the 1990s. The iOS ecosystem is what's made Apple the most valuable company ever, and that began with the iPod and iTunes.
Other companies that have exemplified these characteristics include Under Armour, whose logo has become as ubiquitious as the Nike swoosh, and Green Mountain Coffee Roasters (Nasdaq: GMCR ) , whose Keurig coffeemaker had turned it into a juggernaut before the recent tumble on patent cliff concerns.
2. Growth potential
This part may seem obvious, as pretty much every publicly traded company is focused on growth, but some parts bear explaining.
Stocks can appreciate in two ways: earnings growth or valuation. Of course, earnings growth is preferred, but an increasing P/E ratio is often a sign of a highly regarded brand such as the ones identified above and should not necessarily be a cause for concern.
Look for companies with a growth rate of 25% or more and with plenty of room to expand. In retail, using companies such as Chipotle or Lululemon as an example, this can be as simple as looking at store counts. Considering both companies have just a fraction of the locations of larger competitors McDonald's or Gap, it seems they should be able to grow revenue for years to come as long as their products remain popular.
Growth potential with consumer goods companies can be more difficult to gauge. Look for a low market share, new products in the pipeline, and opportunities abroad. Apple's iPhone, for instance, still has a relatively low market share despite trouncing the competition in profits.
Perhaps the best example of a company that keeps generating new growth opportunities is Amazon.com (Nasdaq: AMZN ) . Though its consistent top-line advances have not fed earnings, the company has repeatedly redefined industries and invented new opportunities for itself, whether they be in digital media, mobile hardware, or creative bundling services like Amazon Prime. It's those opportunities that make it the only company of its size that could justify a P/E of 300, and why its shares are worth than 100 times what they were when they came on the market.
Finally, the third quality to look for in a potential 10-bagger is the right size. Companies like Apple and Amazon clearly have mass appeal and growth potential, but are too big already to grow 10 times in size. Even most of the other companies listed above are already worth around $10 billion in market value, and considering only a small list of companies have reached $100 billion, it seems like we should be looking at smaller targets.
A market cap of around $1 billion seems like an ideal size for a potential 10-bagger. Companies this big are small enough to have room to grow, since $10 billion is a reasonable goal for most publicly traded businesses, but they're also big enough to have proven themselves, have a track record, and are generally profitable.
Chipotle, Lululemon, Green Mountain, and Netflix were all in this $1 billion range before their shares took off. For young growth companies, that cusp seems to be a good indicator of when to invest.
Now that we've examined the primary factors to use in identifying potential 10-baggers, I'll next take a look at a few stocks that fit these criteria. Click here for my next article, where I'll discuss stocks that I think could become 10-baggers.
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