Which Stocks Will Be 2020's 10-Baggers?

Pop quiz, hot shot. Name the company that's most likely to be a 10-bagger by 2020.

It's a hard question. There isn't just one correct answer -- you can find three candidates here -- but it's easy to weed out some popular incorrect answers. 

If you named Research In Motion (Nasdaq: RIMM  ) , Merck (NYSE: MRK  ) , Coca-Cola (NYSE: KO  ) , or any other large-cap company, you're probably wrong. They're simply too big to grow tenfold in the next decade. My Foolish colleague Tim Hanson has shown year in and year out that a decade's biggest winners are small-cap stocks.

He found that the largest grower of the past 10 years, weight-loss company Medifast, was better than a 90-bagger. Even at 90 times its original market capitalization, Medifast is just a $500 million company; Research In Motion is 70 times bigger, Merck is 200 times bigger, and Coca-Cola is 250 times bigger.

It gets better
Besides having room to grow, small caps have another hidden feature. They are more volatile than their large-cap brethren. This can lead to fluctuations that are absolutely heartbreaking for investors with low risk tolerances. But for those of us with higher risk tolerance, the volatility provides opportunity.

As we've seen recently, large-cap stocks can be quite volatile, too. When their price losses significantly outstrip the market's, though, there's usually something terribly amiss.

Familiar examples are former blue chips AIG (NYSE: AIG  ) , Citigroup, and Fannie Mae (NYSE: FNM  ) . If they recover, each could be a multibagger from here. However, they're all priced at fractions of their former highs because each faces a huge "if." At this point, they're speculations more than investments.

Meanwhile, small caps are a little different. Because they tend to have greater volatility than the market as a whole, sometimes they experience dramatic stock price tumbles on very little news. Or even on relatively good news.

A quick example
Let me take you back to fall 2008 and restaurant company Buffalo Wild Wings (Nasdaq: BWLD  ) . In late October, it reported quarterly earnings that were disappointing. But given the state of the economy in general (read: panic) and the restaurant sector specifically, the results were downright robust: positive earnings-per-share growth and impressive same-store sales growth (6.8% at company-owned stores).

In response, shares were sliced in half in the month following the earnings release ... only to gain it all back and then some after the company beat analyst expectations in the subsequent quarter. Over those months, it remained the same company with the same long-term prospects. There were no huge company-related events, and its price was about the same a few months after the earnings release as it was a few months before.

But somewhere in the middle, the market threw a half-off sale for investors patient enough to wait for a discounted entry point. Because they took advantage of volatility, those investors need only a five-bagger (or less) from here to reach the vaunted 10-bagger status.

The 10-bagger club
In 2020, when we look back at the decade's list of 10-baggers, the list will be dominated by stocks that can be described as:

  • Small
  • Volatile

The list of investors who profit from these 10-baggers will be dominated by people who can be described as:

  • Patient
  • Risk-tolerant

If you have these two qualities, I invite you to join our analysts at the Motley Fool Hidden Gems newsletter. They are putting the Fool's money where its mouth is by building a real-money portfolio of small-cap stocks. You can see all the companies they're investing in with a free 30-day trial. If you're not impressed, there's no obligation to subscribe.

Already subscribed to Hidden Gems? Log in here.

This article was originally published on May 15, 2009. It has been updated.

Anand Chokkavelu owns shares of Citigroup. Buffalo Wild Wings is a Motley Fool Hidden Gems pick. Coca-Cola is an Inside Value and an Income Investor recommendation. The Fool has a disclosure policy.


Read/Post Comments (3) | Recommend This Article (22)

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 January 10, 2010, at 10:21 PM, ImaBeachBum wrote:

    In n Out is a privately owned company with no plans to go public. If it's not a public company, it has no chance to multiply for the average investor.

  • Report this Comment On January 11, 2010, at 1:32 PM, xjp83x wrote:

    lol.

    if you are in for in-n-out im in for facebook. =P

  • Report this Comment On January 11, 2010, at 1:44 PM, jeevagjfunds wrote:

    Here is the another opportunity to create Great return....

    How to generate highest return in stock market – Warrens Buffett’s Way. Explained with current stock pick

    Here is the strategy used to attain highest compound annual return in stock market. These formula’s used by great stock pickers like Warren Buffet, Benjamin Graham and Charlie Munger to generate consistent and high compound annual return for long time.

    Here is the winning formula. As investors we have to look for stock that align with this formula to generate highest return in stock market.

    Temporary bargain price + Fixable error + Solid fundamental value + Able management

    = Highest return

    Here is the past and recent examples those are produced great returns, which are align with above formula.

    Examples from Warren Buffett:

    1. In 1960, American Express (AXP) had salad oil crises, AMEX shares dropped $65/share to $35/share. Warren Buffett partnership invested $13 Million (40% of his partnership fund) in American express. In 2 years, his partnership netted $20 Million profit.

    2. In 1976, GEICO shares dropped from $61/share to $2/share. Over next 5 years,

    Berkshire Hathaway invested $45.7 million. In 1996, Berkshire owned 51% of the

    Company and agreed to pay $2.3 Billion for 49% of the company, which is close

    close to $70/share. For his initial investment which he did it in 1976, Buffett

    Generated 19.45% compounded annual return for 20 years

    Examples from last year:

    1. Citigroup(C) traded around $30 in 2008, In March 2009 touched $0.97/share. In August 2009 it bounced back to $5.23/share. However bought the stock at $0.97/share might have made 530% return in 5 months.

    2. Goldman Sachs traded around $195/share in January 2008 and reduced to $59/share in November 2008. It bounced back to $165/share in Dec 2009. It did generate 270% return in one year

    3. Bank of America traded around $40/share in January 2008 and reduced to

    $2.53/share in March 2009. It bounced back to $15.28/share in December 2009.

    That is 600% return in 9 months.

    Current opportunity: Terex Corporation (TEX)

    Terex Corporation operates as a diversified global manufacturer. The company operates in four business segments: Terex Aerial Work Platforms, Terex Construction, Terex Cranes, and Terex Materials Processing & Mining. Terex Aerial Work Platforms segment offers material lifts, portable aerial work platforms, trailer-mounted articulating booms, self-propelled articulating and telescopic booms, scissor lifts, telehandlers, construction trailers, trailer-mounted light towers, power buggies, portable generators, and related components and replacement parts

    Now we examine how Terex align with our winning formula.

    1. Temporary Bargain price:

    Terex was trading around $74/share in October 2007. Recession started, stock prices reached $8.92/share in February 2009.

    Here is the statistics of the company in 2007:

    2007 yearly revenue: $9.1 Billion, Net income: $613 Million, 2007 Diluted shares = 104.9 million shares, Market cap in October 2007 = $7.76 Billion, EPS=$5.85/share.

    2. Fixable Error:

    Industry down turn started in 2008 and continued in 2009. Terex revenue started declining.

    Terex started managing the business for cash conversion in 2009. Terex long term debt is $1.9 Billion. They have over $1.5 Billion Liquidity and no near term debt maturities until 2012.

    They reduced capital reduction around $199 Million in 2009. They got cash from inventory reduction $497 Million in 2009. They have improved prospects in 2010 and US and emerging markets demand is increasing. So that they can survive this down turn and improve the earnings coming years.

    3. Solid Fundamental value:

    Terex EPS growth from 2004 to 2008 is 16.5% compound. Retained earnings are great. Each dollar retained it created $2.48/share from 2004 to 2008. Average Return on Equity is 22.58% from 2004 to 2008. Owner income increased 12.41% annually from 2004 to 2007.

    Company in the cost conservation strategy to survive the recession, after the recession, probably next year revenue will start grow.

    Here is the intrinsic value calculation assumption. If owner income increased 5% for next two years, 4% for another 3 years. I used higher discount rate to accommodate the uncertainty, which is 20%, In that scenario calculated intrinsic value is $45/share. 1/7/2010, Terex closing price is $22.41/share. Which is 50.2% discount to intrinsic value. This perfect investment.

    4. Able Management:

    Recently management Divestiture of mining business to Bucyrus international for $1.3 Billion cash. Through 2004-2008, mining has accounted for 12% and 14% of consolidated net sales

    and operating profit respectively. 2008 Net sales with Mining = $9.9 Billion, 2008 Net sales without mining = $8.4 Billion. Company is planning to concentrate on machinery and industrial production. Company projecting to earn EPS = $8.5/share in 2013 that is double the business.

    The company is planning to use the cash to pay down the debt. So Management is doing great job to divest low margin business.

    Terex return projection:

    As per owner earnings projection, Terex will generate around $694 Million that is around $6/share. This stock historically traded between 9 and 17 ratio.

    In 2013, Terex should trade around $54/share to $102/share, which is 24.9% and 46.5% compound annual return for 4 years.

    Do own research before investing in TEX

    Disclosure: Long on TEX

    Author:

    Jeeva Ramaswamy is ardent disciple of Warren buffet and managing partner of GJ Investment funds (www.gjfunds.com) which is value based investment fund focusing on US and emerging markets modeled after 1956 Buffett partnership. Since inception GJ Funds have consistently beaten Dow, NASDAQ and S&P 500 indicies and 95% of the mutual and hedge fund managers by wide margin. He can be reached at jeeva@gjfunds.com

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