The 10-Bagger That Gave You No Chance

I've taken to making Panera Bread (Nasdaq: PNRA  ) my office away from the office. Until recently, when I needed a quieter spot than my child-controlled house to get a little work done with Wi-Fi access, I'd use Starbucks (Nasdaq: SBUX  ) . But because Starbucks charges for this service, and Panera doesn't -- and because Starbucks charges for my second, third, and fourth cups of coffee, and Panera doesn't -- the choice became pretty easy.

Wanting to know a little bit more about my new hangout and whether its continued expansion might ever affect Starbucks, I started investigating Panera. A recent Investor's Business Daily (IBD) article caught my eye: "Swings, Shakeouts Make Some Stocks Too Hard to Handle."

Blah, blah, blah
The thrust of the article is this: Using charts and graphs as your primary basis for buying Panera, there was virtually no time at which it offered much of a buying signal. Though the article does mention the three weeks after June 16, 2000, when a signal was formed by Panera's "cup" and "handle" -- the dip down, swoop upward, and leveling off of its chart -- the author concludes, "We wouldn't have blamed you if you saw this as a poor opportunity and passed." In part, the lack of clarity of the buy signal was because "the handle was wedging higher amid choppy volume, as the stock rode its 10-week moving average. Normally you'd want to see a downward-sloping handle with near-dead activity."

Well, yes. Maybe. Whatever he just said. But the stock doubled by the end of 2000. Even if you'd bought the stock then, the article indicates that you would have been right to sell it at many different times on its way up. In fact, for those who bought and held, the stock has moved from a split-adjusted $4.60 per share in mid-June 2000 to today's price of about $48.

Growth gone by
Now, in part, I credit IBD and the author of this piece for not claiming to have a perfect system for identifying all great stocks, even in retrospect. None of us has a perfect system. In this particular case, it appears that technical analysis most likely would have let you down when determining to buy the stock.

We're all looking for systems that are going to lead to the multibaggers of the world. So my next question is: What fundamental analysis system would have identified the company as an exciting buying opportunity at that point in time?

To answer that, I first looked at the historical data to find out what the balance sheet and income statements told me over the years. It turns out that in 2000, Panera was trading for approximately its book value, and early in the year it had a price-to-earnings ratio below the market average. Those are nice things to find in combination with a potentially explosive growth story -- even if the handle is wedging higher amid choppy volume. Whatever that means.

But Panera's price-to-book ratio had been below 1.0 off and on for five years before 2000. What made this moment a good opportunity?

Enter the catalyst
Conveniently enough, on June 13, 2000 -- just three days before a hindsight reading of a technical chart vaguely pointed to ... something -- my friend and former colleague Warren Gump published a very prescient piece in our annual "Stocks for Dad" feature, recommending Panera to his father (and the rest of the world).

I'll let Warren's work speak for itself, but the reasons for his recommendation can be summed up as follows:

  • Wide market opportunity
  • Recently upgraded balance sheet
  • Consistent profitable operations

Much of this was hidden to casual observers in the market because Panera had recently sold off its holdings of Au Bon Pain, which were dramatically weighing down the company. Released from the burden of the disappointing chain -- and flush with cash from the sale -- Panera was free to grow the profitable side of its business. None of this, of course, was information available in the charts. Over the next year, Panera more than tripled -- and has, all in all, been a 10-bagger since Warren identified the opportunity for readers.

In his write-up, Warren noted that Panera's management believed it could increase earnings by 74% that year and 30% annually thereafter. Those numbers might seem eye-popping to you, but at the time, everybody was expecting huge companies to increase earnings for the foreseeable future at annual rates of 30% or more. Such growth rates were embedded in the prices of solid companies such as Cisco Systems and Microsoft (Nasdaq: MSFT  ) , as well as others with far more alarming balance sheets like JDS Uniphase (Nasdaq: JDSU  ) , Juniper Networks (Nasdaq: JNPR  ) , and Ciena (Nasdaq: CIEN  ) . Those growth projections were highly improbable for companies capitalized in the tens or hundreds of billions -- especially when applied to companies with precarious balance sheets and little cash flow.

How you can find great growth
But market opportunities of that magnitude are occasionally available in the small-cap arena. That's why at our Motley Fool Hidden Gems small-cap investing service, we're always looking for small, well-managed companies with strong balance sheets and wide market opportunities. So far, that strategy has led to 66% returns for Hidden Gems recommendations, versus 27% returns for the S&P 500 -- and buying (and holding) a number of multibaggers has been a big reason for that performance.

We'll gladly show you how we find and stay loyal to the small-but-growing, reasonably priced, well-managed, cash-flow positive businesses we love. You can sample Hidden Gems with a free, no-obligation 30-day guest pass. We hope you're with us for our next multibagger -- with or without a sloping handle.

This article was originally published on April 26, 2007, as "The 12-Bagger That Gave You No Chance." It has been updated.

Bill Barker finished writing this article and his fourth cup of Panera coffee for the morning at roughly the same time. Bill does not own shares of any company mentioned. Microsoft is a Motley Fool Inside Value recommendation. Starbucks is a Stock Advisor recommendation. The Fool has a disclosure policy.


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