Welcome to the sixth year of my New Year's prognostications! Now that we're officially into 2019, it's time again for me to reveal three growth stocks that I expect to outperform the market in the coming years.
For many growth investors, 2018 was a very challenging year. Trade standoffs with China and a cyclical semiconductor lull caused many to abandon hope in high-tech fields (especially robotics). Fears of rising interest rates punished "overvalued" stocks, and the Nasdaq officially fell into bear market territory. Even after recovering a bit in the final days of December, it still remains nearly 20% off its August high.
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If we zoom our time frame out beyond 2018, we see even more volatility. My previous top stock ideas have included some big winners and also some big losers.
The growing Internet of Things has connected Ubiquiti Networks (UBNT +0.70%) with a 235% gain, and increasing pharmaceuticals regulations have vaulted Veeva Systems (VEEV 0.17%) shares by 238%. Conversely, nonexistent consumer 3D printing demand has built mounting losses for Stratasys (SSYS 1.17%), and erratic behavior from Elon Musk has kept Tesla (TSLA 0.86%) shareholders (who acquired SolarCity in 2016) with one foot on the brake.
But, altogether, the performance of the picks still makes a strong case for growth-style investing. Taken together, 2014's picks have gained an average absolute return of 52%, 2015's have returned 132%, 2016's have returned 76%, 2017's have returned 54%, and last year's have returned 3%. All five sets of annual picks are beating the S&P 500 during the same time frame.
| Company | Starting Price | Recent Price | Total Return |
|---|---|---|---|
| Stocks for 2014 | 52% | ||
| SolarCity* | $57.35 | $36.61 | (36%) |
| Zillow | $26.79 | $31.43 | 17% |
| MercadoLibre | $106.88 | $292.85 | 174% |
| Stocks for 2015 | 132% | ||
| Ubiquiti Networks | $29.64 | $99.41 | 235% |
| Stratasys | $83.11 | $18.01 | (78%) |
| Veeva Systems | $26.41 | $89.32 | 238% |
| Stocks for 2016 | 76% | ||
| Splunk | $57.20 | $104.85 | 83% |
| FireEye | $21.64 | $16.21 | (25%) |
| Arista Networks | $78.28 | $210.70 | 169% |
| Stocks for 2017 | 54% | ||
| Illumina | $134.56 | $299.93 | 123% |
| Ellie Mae | $83.20 | $62.83 | (24%) |
| 2U | $30.60 | $49.72 | 62% |
| Stocks for 2018 | 3% | ||
| Invitae | $9.34 | $11.06 | 18% |
| Baozun | $33.66 | $29.21 | (13%) |
| iRobot | $80.10 | $83.74 | 4% |
| S&P 500 | |||
| Since 2014 | 1,662.50 | 2,499.20 | 50.3% |
| Since 2015 | 1,890.09 | 2,499.20 | 32.2% |
| Since 2016 | 1,916.17 | 2,499.20 | 30.4% |
| Since 2017 | 2,145.35 | 2,499.20 | 16.5% |
| Since 2018 | 2,613.68 | 2,499.20 | (4.4%) |
DATA SOURCES: YAHOO! FINANCE AND S&P DOW JONES INDICES. STARTING PRICES ARE AS OF THE ORIGINAL PUBLISHING DATES: 12/30/13, 1/1/15, 1/5/16, 1/5/17, AND 1/2/18. STARTING PRICES OF THE S&P 500 HAVE BEEN ADJUSTED TO ACCOUNT FOR DIVIDENDS. ALL TOTAL RETURN FIGURES FOR STOCKS ALSO INCLUDE DIVIDENDS. ZILLOW SPLIT INTO TWO CLASSES DURING 2015; WE ARE TRACKING "ZG." SOLARCITY WAS ACQUIRED BY TESLA MOTORS IN NOVEMBER 2016 IN AN ALL-STOCK DEAL; THE RECENT PRICE REFLECTS THE EQUIVALENT OF 0.11 SHARES OF TSLA AT $332.80. PRICES AND RETURNS ARE AS OF END-OF-YEAR 2018. FIGURES HAVE BEEN ROUNDED.
Within this growth-investing strategy is a key element that is worth calling special attention to. The outperformance of the winners more than makes up for the underperformance of the losers.
This is a dynamic we've become comfortable with. We know that, historically, only about 40% of the individual recommendations from our Motley Fool Rule Breakers service outperform the S&P. But, when taken collectively, the portfolio of picks has an average absolute return of 121%, which is more than double the 58% return of the market over the same period (figures are as of 1/2/2019).
That formula for wealth creation is only possible if you allow your winners to run (i.e. not selling), allowing them to compound their returns over time and to trump the losses from the laggards. But it also requires identifying the right companies at the right time, and having a lot of patience.
The process
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 2019.
1. The Trade Desk (TTD +4.78%) is emerging as a leader in programmatic advertising. The company's AI-powered algorithms place more than 6 million digital ads across the internet every second, and they get smarter with each one they place. That means that when you surf the web, you should start seeing advertisements for products you're actually interested in purchasing.
Ad agency customers are also interested in this highly optimized online auction as a way to improve their marketing ROI. The Trade Desk's take rate -- which is their revenue as a percentage of their clients' gross spend -- has been greater than 20% for each of the past three years. That's a great sign that customers see value in their platform. And they could have a huge hit in internet-connected TVs, where company revenue has increased 10-fold year-over-year for each of the past three quarters. With the world spending $672 billion each year on advertising, there's plenty of room for the $50 billion programmatic industry to grow.
Founder and CEO Jeff Green was previously a digital media buyer, but quickly recognized the opportunity for more transparent, real-time advertising. As an excellent steward of shareholder capital, he's helped The Trade Desk report positive earnings and positive cash flow in every quarter since its IPO.
That combination of accelerating and profitable growth sounds like a match made in heaven. I think The Trade Desk is worth a closer look.
Check out the latest The Trade Desk earnings call transcript.
2. MongoDB (MDB +0.04%) is disrupting databases, which have long been dominated by one very large competitor (Oracle). But the world's commercial data is changing. The rows-and-column transactional data typically stored in Excel is being replaced by free-form social media posts and unstructured device sensor data. Mongo's general-purpose databases are better equipped for these new forms of data. They're also open-source, meaning developers can build business-specific applications on top of them to make sense of what everything means.
Mongo's cloud-based database-as-a-service recently quadrupled its revenue and now accounts for 22% of the company's top line (up from just 8% last year). And even though Mongo's customer count recently increased by an impressive 69% to 8,300, more than 40 million people have downloaded their databases for free. That means a ton of developers are tinkering around with Mongo's products, which would suggest that their customer count will increase even more in the coming years.
MongoDB was founded by the same team who created DoubleClick in the mid-90s, which was later acquired by Google for $3 billion. Four key leaders of their executive team (co-founder Dwight Merriman, CEO Dev Ittycheria, CTO Eliot Horowitz, and Sequoia partner Roelof Botha) together control more than 50% of the company's voting power.
MongoDB could be storing some great future returns for investors.
Check out the latest MongoDB earnings call transcript.
3. Nutanix (NTNX +1.70%) is bringing the ambitions of cloud computing down to earth. There are several public cloud vendors -- such as Amazon Web Services, Google Cloud Platform, and Microsoft Azure -- who each have features that companies would like to incorporate within their own private infrastructures. Nutanix's hypervisor allows them to get the best of all providers, setting up multi-cloud strategies to control costs, to manage applications, or to stay in regulatory compliance.
Nutanix is shifting away from hardware in favor of selling higher-margin subscription-based software. While this move has pressured their top-line to some extent, it has also greatly improved profitability. Gross margin increased from 61% to 76% during the past twelve months, as subscription revenue more than doubled and now accounts for more than 50% of forward billings.
The top six cloud vendors now do more than $60 billion of annual sales and are growing very quickly. Co-founder, CEO, and Chairman Dheeraj Pandey was once a distinguished graduate from the India Institute of Technology. He controls 23% of the company's voting power.
Nutanix ensures that there will continue to be more clouds on the horizon (in a good way).
Check out the latest Nutanix earnings call transcript.
The Foolish bottom line
Great businesses can lead industrywide changes that really shake up the status quo. The Trade Desk, MongoDB, and Nutanix all have visionary management teams who are capitalizing on the world's largest business opportunities. While none is immune to the market's short-term volatility, I foresee each of them producing excellent long-term returns for patient investors.
