Last autumn we left our comfort zone -- which is large, dividend-paying companies that offer free dividend reinvestment plans -- to venture into the world of small, high-growth companies that don't pay dividends and don't have dividend reinvestment plans. There is something odd about this pursuit -- something like Zsa Zsa Gabor trying her hand at a pizza delivery job.

Why are we doing it?

With the advent of very low-cost discount brokers, including ShareBuilder and BUYandHOLD, we decided that if we could find a high-growth company likely to grow enough to compensate for the commissions that we would pay to buy shares regularly, the young company might help our portfolio beat its 15 %annualized performance goal. With that hope, we developed high-growth company investment criteria and started our search for an investment.

Now that we have just ten finalist companies remaining in our study, the following are our investment criteria updated and expanded, with new criteria added, and with all criteria organized by subject matter for the first time. Our high-growth company should meet the following qualities (note: I must read this list very slowly in order to really think about it, but maybe that's just me):

Business Qualities...

  • The product or products sold must deliver value to a growing customer base, and should do so on a recurring basis;
  • The existing business(es) must have an attractive, quantifiable long-term growth opportunity;
  • There must be many new, related business opportunities, or what some call "option value;"
  • Perhaps most importantly, the company must possess a sustainable competitive advantage over competitors and potential innovations, meaning there must be a protective "moat" around the business that we can describe, explain, and validate;
  • Related to sustainable advantages, a logical argument supporting 16 years of significant growth for the company itself, not just the industry, must exist.

Management Qualities...

  • Management must have a long-term focus demonstrated by its business plan, goals, mission, and values statement; in conference calls, initiatives, and how it runs the business; and through its regular dealings with the media and investors;
  • Management must have a history of honest, candid operations and investor relations people who are willing to speak with investors;
  • Management must demonstrate a marked lack of focus on the stock price! We want management to manage the business on the premise that a good business will automatically take care of the stock price. We do not want management to try to manage the stock price, because that eventually leads to trouble;
  • We want management that is experienced in a way that is relevant to the business in question, and we want top officers who have proven in the past that they're out to build a business, rather than a personal reputation;
  • Management must have good relations with company employees.
  • Finally, we'd rather that management did not give long-term, aggressive performance guidance that makes the company vulnerable to disappointment. True investors don't need that.

Financial Qualities...

  • The business should become more profitable per dollar of revenue earned the more that it grows, meaning that it scales;
  • The business should be self-financed with positive cash flow, and the balance sheet should show cash of more than 1.5 times long-term debt;
  • Some income must be reinvested back in the business with demonstrated effectiveness and the promise that that will continue;
  • The business should have a Cash King Margin of 20% or higher and generate strong free cash flow, and a Foolish Flow Ratio below 1.4, or, these lacking, it must promise to eventually exceed these benchmarks;
  • The higher the gross margin, operating margin, and return on invested capital, the better (this is considered on a case by case basis);
  • We must be able to logically estimate an annual five-year sales growth rate of at least 20%, or the promise to exceed that;                 
  • Likewise, we must be able to logically estimate annual five-year earnings per share growth of at least 25%, or, if unprofitable now, a strong promise to soon exceed 25% annual earnings growth;
  • Following five years of rapid financial growth, we must logically be able to estimate naturally slowing growth afterwards, rather than a sharp dropoff in growth.

Valuation Qualities...

  • The company must have a market capitalization of between $300 million and $50 billion (we're not too targeted with this range, obviously);
  • The stock must be priced such that the company's pending high growth will likely reward shareholders in kind, rather than just "catch the company up" to its share price. By necessity, we'll address this on a case by case basis, focused on discounted cash flow projections;
  • Over recent history, the stock's daily dollar volume (shares traded multiplied by price) should be increasing, not decreasing.

Whew! That's a lot to demand from one company.

Meanwhile, the high-growth study continues. This week on the Drip Companies discussion board, I posted thoughts on the hurdles that we must overcome in order to make a high-growth purchase (mainly, the spectre of commissions). I also touched on investing versus speculation and listed our ten finalist companies. This was all in a new post sharing general thoughts on the high-growth study.

In a second post, I suggested that three companies get cut from the list of finalists right off the bat. If you're interested in the study, read these posts. This is a collective effort, and it will take place almost entirely on the board. If you have thoughts after reading this column and those posts, please post them, as others are doing.

See you out there!

Jeff Fischer thinks "Celebrity Survivor" is a tame idea. Isn't trying to determine new people's true characters a big part of the show's success? If well-known celebrities are on the show, where's the mystery? Plus, isn't it just another movie set to celebrities? Not that Jeff really cares. He saw two whole episodes of the last "Survivor" series. But still. The Fool has a full disclosure policy.