Welcome to the fifth year of my New Year's prognostications. Now that we're officially into 2018, it's time again for me to reveal three growth stocks that I expect to outperform the market in the coming years.
As is often the case for growth-style investing, my previous lists have had some big winners and some big losers. Because of the adoption of e-commerce among Latin America's middle class, MercadoLibre (NASDAQ: MELI) has nearly tripled since the beginning of 2014. But lackluster demand for 3D printing and related services has caused Stratasys' (NASDAQ: SSYS) stock to fall by 76%.
Overall, 2014's picks have gained an average absolute return of 69%, 2015's have returned 58%, 2016's have returned 71%, and last years have returned 60%. All four annual sets of picks are significantly outperforming the S&P over the same time frame.
|Company||Starting Price||Recent Price||Total Return|
|Stocks for 2014||69%|
|Stocks for 2015||58%|
|Stocks for 2016||71%|
|Stocks for 2017||60%|
The volatility of this roller coaster of ups and downs might keep some investors up at night. But over time, the math behind it tends to work out in our favor.
Historically, only about 40% of the individual recommendations from our Motley Fool Rule Breakers service outperform the S&P 500 over the same time frame. But when taken collectively, the portfolio of picks has an average absolute return of 135%, which is double the 67% the market return over the same period.
Growth-style investing works best when you allow your biggest winners to run. They compound their returns over time and overcompensate for the losses from the laggards. But it also requires identifying the right companies at the right time and having a lot of patience.
To help identify those big future winners, here are three qualities I always look for in growth companies:
1. Operational performance. When you invest, you're buying a stake in a business, so you want to find businesses that are performing very well. Develop a list of meaningful operational metrics that are relevant to the particular industry, and then look for companies that are killing it where it really counts. That means putting less emphasis on the current P/E ratio, and more on metrics that evaluate business performance.
2. Smart and visionary management. Growth companies are still growing. That makes them much more sensitive to managerial decisions -- whether good or bad. Look for leaders who are committed to the long-term success of the company. I like CEOs who are either co-founders or who have a significant ownership stake -- preferably both.
3. Huge market potential. Small companies don't always do so well in price wars. Find industries large enough to support a new player. I look for the company's total annual revenue to be a very small slice of the overall industry.
This year's list
With all that said, it's now time to fire up the crystal ball once again. Without further ado, here are my three top recommendations for 2018.
1. Invitae (NYSE: NVTA) is bringing genomics into mainstream medicine. The company's cloud-based platform collects a patient's DNA and can screen more than 1,000 problematic genes to detect conditions such as hereditary cancer, neurological conditions, or cardiovascular disorders. Invitae's proactive health screens can be predictive of future conditions, which will play a crucial role in America goal of having a more effective and less costly healthcare system built on personalized medicine.
Invitae has now collected more than 40,000 patient samples, which is 158% greater than the 15,500 it had a year ago. The costs related to genomic sequencing are also falling rapidly, which has prompted several insurers to begin to embrace it. That means Invitae's costs are dropping while its addressable market is expanding, which is a great combination to see.
Founder and CEO Randall Scott previously founded and ran Genomic Health, which he grew from a start-up into a $1 billion public company. He now wants Invitae to provide the necessary infrastructure for genomic diagnostic tests to go mainstream. To achieve that goal, the company has made smart acquisitions to grow methodically into the $3 trillion U.S. healthcare market.
Invitae's genomic platform could offer some great returns for investors.
2. Baozun (NASDAQ: BZUN) offers companies an opportunity to sell to the world's largest (and fast-growing) middle class.
Fondly referred to as the Shopify of China, Baozun handles the behind-the-scenes work for retailers to set up shop for e-commerce sales. That includes managing inventory, handling logistics, setting up online storefronts, and using artificial intelligence to optimize performance. The company is integrated with China's largest consumer-facing sites -- Alibaba's Tmall and JD.com -- which gives its customers, including Microsoft and Nike, access to more than 700 million internet users who spend $700 billion online each year. Also worth noting: Alibaba owns approximately 17% of Baozun's outstanding shares, while Softbank owns another 13%. Both of these massive companies are flush with resources and have a vested interest in seeing them succeed.
Baozun is shifting from a distribution to a service fee business model, which means it's prioritizing profits over top-line growth. It recently reported a 71% increase in gross merchandise volume and a 15% increase in customer count. As the company adjusts its business model, we should watch closely for growth in services revenue to significantly outpace that of its costs of goods sold and its operating expenses. In the most recent quarter, services revenue was up 55%, compared with a 19% increase in operating expenses and a 3% reduction in the cost of goods sold. So far, so good.
CEO Wenbin Qiu co-founded the company back in 2007, and Baozun's directors and executive officers collectively own 50% of the company's outstanding shares.
E-commerce is coming alive in China's middle class. Baozun is a sleeping dragon ready to awaken.
3. iRobot (NASDAQ: IRBT) sells autonomous robots to make our lives easier. You've probably seen the company's Roomba vacuum cleaner on display at your local Lowe's or Home Depot, but iRobot also sells consumer bots that mop floors and clean pools. With technological improvements -- such as advanced sensors, wireless connectivity, and neural networks -- alongside falling costs, the company's robots are now ready for the mass market. That should provide serious profits.
The Boston Consulting Group recently raised its market forecast for consumer robots in 2025 from $9 billion to $23 billion, citing applications such as self-driving cars and applications around the home. iRobot founder and CEO Colin Angle is seizing the opportunity, by expanding its core technology into new product lines and bringing international sales in-house to improve margins. The company sold 3 million consumer units last year, which was up 20%. That's already a great growth rate, but we'll watch for it to accelerate even more in the coming years.
With the rise of autonomous robots, iRobot is ready to sweep in big returns for investors.
The Foolish bottom line
Great businesses produce great results. Invitae, Baozun, and iRobot all have visionary management teams that are capitalizing on several of the world's largest business opportunities. Each of these companies is still small, which could result in significant short-term stock price volatility. But they're also beginning to form strong competitive advantages, which could allow them to capture profits and provide great returns for investors.
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Simon Erickson owns shares of Baozun, Invitae, iRobot, JD.com, MercadoLibre, and Shopify. The Motley Fool owns shares of and recommends iRobot, JD.com, MercadoLibre, and Shopify. The Motley Fool recommends Stratasys. The Motley Fool has a disclosure policy.