A Value Lollapalooza

Charlie Munger, Warren Buffett's curmudgeonly brilliant partner at Berkshire Hathaway, loves to talk about "lollapalooza effects" -- a combination of factors in a given business that can produce exponential investing returns.

You want your portfolio to grow exponentially, right? (Who wouldn't?) Let's list these lollapalooza effects and see how they can work for you.

Increasing sales and margins
Apollo Group (Nasdaq: APOL  ) provides higher education to working adults. As today's business world grows more competitive, Apollo is helping people get smarter, advance their careers, and create value for their employers.

That's all well and good for employers, but how has Apollo created value for shareholders? By combining sales growth with margin growth.

8/31/02

8/31/03

8/31/04

8/31/05

Sales Growth

31.2%

32.7%

34.3%

25.2%

EBIT Margins

25.1%

28.9%

31.2%

32.5%

Price

$41.83

$64.07

$78.00

$78.66



From the numbers above, you can see the great job Apollo has done over the past few years. The market rewarded that performance with terrific stock price appreciation. Now, what happens when we add another factor to the mix?

Great working capital management
Coach (NYSE: COH  ) makes upscale fashion accessories. If you have a wife or daughter, there's a good chance you've shelled out some money for a Coach product. Since its spinoff from Sara Lee in 2000, Coach's stock price has moved upscale as well.

How does Coach do it, you ask? From the numbers below, we see that great sales growth, great margins, and great working capital management produce tons of free cash flow.

6/29/02

6/29/03

7/3/04

7/2/05

Sales Growth

19.8%

32.5%

38.6%

29.5%

EBIT Margins

18.8%

25.4%

33.4%

36.2%

Change in net working capital*

$17.3

$16.0

$18.3

$(29.8)

Free cash flow*

$50.2

$104.9

$228.7

$379.2

Price

$6.86

$14.51

$21.08

$33.57

*Dollars in millions.

Coach has been around since 1941. Could a future competitor come in and displace it? Although Coach's brand gives it considerable protection, an upstart rival remains a possibility, since Coach competes with many other upscale retailers. Let's look at a business that fears no competitor, thanks to the final lollapalooza factor.

A huge moat
eBay (Nasdaq: EBAY  ) is a household name and a huge retailing force. It has strong growth, healthy margins, and lots of free cash flow. But most importantly, I think it has the biggest moat in the business.

eBay competes using not one, not two, but three parts that keep customers coming back for more. eBay.com brings buyers and sellers together. PayPal makes it easier for those buyers and sellers to exchange money online. And the newest addition, Skype, allows those buyers and sellers to communicate instantly and conveniently.

By combining these networks to facilitate buying and selling, eBay makes it difficult for competitors such as Amazon.com (Nasdaq: AMZN  ) and Overstock.com (Nasdaq: OSTK  ) to jump in and catch up. No wonder its stock has increased an average of 49% a year for the past seven and a half years.

But don't forget ...
There's always a catch. In this case, these companies are almost never cheap. The market quickly recognizes their potential, and investors compete to purchase shares, driving the price up.

But that doesn't mean you shouldn't look for firms like these. To get started on your search, follow three characteristics used by our analysts at Motley Fool Inside Value:

  1. Products and services with mass appeal.
  2. Pricing power.
  3. Focus.

In concert, these factors can help your portfolio grow exponentially. That's why it's important to know how to find them and hold them for the long term. Philip Durell uses just such a strategy at Inside Value, and it's helped him beat the S&P 500 by more than four percentage points since the inception of his newsletter service. If you'd like full access to Philip's recommendations, CEO interviews, and Foolish insights on value creation, sign up for a free 30-day guest pass.

For more on value creation, check out:

David Meier does not own shares in any of the companies mentioned. eBay and Amazon.com are Motley Fool Stock Advisor recommendations, and Sara Lee is a Motley Fool Income Investor pick. The Motley Fool has a disclosure policy.


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