We have outlined why Drip Port is seeking a higher-growth, younger investment now that we have a portfolio of stable growers that we've built over the last three years. We have also listed four dozen companies that are growing at rapid rates. Now we begin to fine-tune our new search by explaining the criteria that we are seeking from our high-growth investment candidates.
Since the company that we eventually buy will likely be relatively young, we will need to measure its quality primarily on subjective business factors rather than on many quantitative measures. However, our criteria include both qualitative and quantitative measures, and all of our criteria are important.
To qualify for our high-growth investment...
-- The company must have endlessly expanding new business opportunities, and these opportunities must be related to the current business. Nobody can predict the future, but we can all envision how a company such as America Online or Yahoo! possesses many opportunities to expand into new, related businesses, while a company that builds airplanes or produces wine does not.
-- The company must already possess a business that can expand on its own endlessly as well. The best biotechnology companies will endlessly create new and better drugs to treat disease, while a company such as Coca-Cola can always sell one more Coke or bottle of water. These are businesses that can always expand during our lifetimes. Many companies do not have this luxury. Several companies have business lines that will always have a limited market and, therefore, lack room for endless expansion. We will avoid those.
-- The company must have a business that we can reasonably project will be much stronger and much larger in 17 years. For example, a leading pharmaceutical company today that continues to lead in drug creation will be much larger in 17 years. That is almost inevitable. Likewise with telecommunications and wireless leaders. However, it is not nearly as easy to assume that the leading airplane builder or the largest oil conglomerate will grow much larger over this time. These giants may continue to lead, but will they grow at market-topping rates or even grow much at all?
-- The company must have management and investor relations that will speak to us directly -- on the phone, through e-mail, or in person if we desire (ding-dong! anybody home?). We mean this within reason, of course. We will not call management at home on the weekends, nor will we follow them in our cars. We simply must be able to come to know management and their business firsthand or we will not invest in it.
-- Depending on the situation, the company must have recent annual sales growth of more than 20% year-over-year, or it must have very strong potential for considerably higher annual sales growth once its sales start to kick in. Why will we grant this leeway? Because we do not want to forego the most promising companies just because they have not yet begun to sell their new widget -- be it a networking device, a handheld wireless product, or a drug coming out of Phase III trials. If a company's sales are already established, however, then we must see recent sales growth of at least 20% annually. If sales are not yet established, we must see great promise.
-- The company must have strong working capital and cash flow dynamics. This will be analyzed on a company-to-company basis because coating all companies with the same brush when it comes to working capital and cash flow is often illogical. On an individual basis for each company, we will consider free cash flow (which, on the cash flow statement, is cash flow provided by operations, or "operating cash flow," minus capital expenditures), the Foolish Flow Ratio (which must be below 1.4 for us), and the Cash King Margin (which must be above 20% for us). If a company is not mature enough to reasonably meet these quantitative hurdles, then its business must promise to one day exceed them for us to consider buying it. Again, why the leeway? Because we don't want to miss a company's high-growth youth by measuring it on unrealistic expectations too early in its life.
Tomorrow we'll conclude our criteria outline and then we'll be ready to pare down our list of company candidates. These criteria are a work-in-progress, however, and they are here for continual improvement from readers. So, if you have any thoughts about our first high-growth criteria, please share your thoughts! Until tomorrow...
--Jeff Fischer, TMF Jeff on the boards
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