It has been an epic year for automotive pioneer Tesla (TSLA 4.06%). The company's share price exploded nearly 700% higher in 2020 and recently topped $700 billion market cap value -- making it not just the world's most valuable automaker, but one of the world's most valuable companies, period. Not everyone may agree with the sky-high price tag, but there's no denying Tesla has gone from niche stock to mainstream success.
But a new digital era is dawning, hastened on by the pandemic. There are other companies out there poised to make a Tesla-like run in the decade ahead. Here are some tips to help spot them early on.
1. The company is relatively small
To enjoy Tesla-like returns, investors should be looking for small companies. But what is "small"? A small-cap stock is defined by an arbitrary market capitalization of $2 billion or less, but such sizing is relative.
At the end of 2016, Tesla was valued at just over $34 billion -- far from what would be considered a small business. However, there are dozens of auto brands worldwide, selling tens of millions of cars every year, and yet very few sell electric vehicles. This gave Tesla massive potential.
Focusing on other businesses that are small relative to their industry is key here. Take one of my favorites, Teladoc Health (TDOC -2.18%). Even after an incredible 1,000% run-up over the last five years, the leader in virtual healthcare is currently valued at a market cap of just under $29 billion. It's a big business by anyone's measure. But considering healthcare spending is homing in on $4 trillion in the U.S. every year alone -- and that Teladoc operates in 175 countries -- this company is tiny compared to the massive industry it operates in.
Finding fast-growing but small companies relative to the market they operate in is the first step in identifying stocks with huge potential. Given the wide-open space in the healthcare universe, Teladoc stock's growth the last few years could only just be getting started.
2. The company is defining a new and potentially massive industry
I was actually an early believer in Tesla after its 2010 IPO. I was a young(er) and dumb(er) investor, though, and after seeing a tidy profit after a couple of years, I took some bad advice and sold. Specifically, I allowed myself to be convinced Tesla was simply making cars with batteries in them.
But what I missed was Tesla wasn't just a new automaker, it was redefining the industry with a mission to disrupt energy infrastructure itself and help the world transition away from fossil fuels. Other mega-cap companies like Tesla have this visionary mindset in common. Sure, there are many such stocks with similar aspirations that fail. But don't discount a business's chances if it has experienced early success in this regard.
One such company is Sea Limited (SE -0.25%). Its stock had an epic 380% run in 2020 but is still valued at under $100 billion as of this writing. Sea is undeniably a premium-priced stock. However, e-commerce is still a small fraction of retail sales in Southeast Asia overall (as well as in Latin America where Sea is now expanding its Shopee online retail app). Add in a digital payments operation, the fact that Sea recently applied for a banking license in its home country of Singapore, and an online video game platform that's still winning over new players, and this technologist clearly has big aspirations for multiple overlapping industries in Southeast Asia and beyond.
Tesla's success illustrates the possibilities for a company like Sea that's riding high on momentum. That momentum aids in the company's efforts to gain new customers as well as expand with new product and service offerings, both of which can help make for a bigger and more profitable company down the road. I've since rectified my mistake with Tesla years ago and no longer sell off my winning stocks. Sea looks like one of those early winners with plenty of potential still ahead as it redefines the shopping experience in emerging markets with its e-commerce platform.
3. Customers love the company's product or service
One aspect of Tesla's incredible story is it built its nascent EV empire with little money spent in advertising. Positive word of mouth and rave customer reviews were key factors in Tesla delivering 500,000 vehicles in 2020, up from just shy of 76,000 in 2016.
Customers who love a product or service are key in helping a business expand. Loyalty means stable repeat business. Positive word of mouth generates new customers and new fans with little in the way of marketing expense. But measuring just how happy customers are can be difficult. A company adding lots of new users (as reported in quarterly earnings reports) is one key metric to watch. So is a good Net Promoter Score (NPS), a third-party metric measured by subtracting negative customer reviews from those customers who say they'd recommend a service or product to others. Add that to a disruptive operation in a large market, and happy users can equate to lots of future growth.
Cloudflare (NET 1.11%) is generating lots of positive buzz in this regard. The company has hundreds of thousands of users, most of whom get a basic web security or content delivery service for free. But as the company moves upmarket and offers its services to larger businesses, the positive reviews Cloudflare is generating from its next-gen edge networking (which expands on the massive cloud computing industry by bringing data and services closer to the end user to improve performance) are leading to lots of new business. It also has a best-in-class NPS well above that of its peers like Fastly and legacy web content delivery network Akamai.
In fact, all three of these companies -- Teladoc, Sea Limited's Shopee app, and Cloudflare -- have lots of customers who are happy brand advocates. As each company continues to disrupt the status quo in their respective industries, customers who love their service could be a key differentiator that separates them from the competition. If a business is to achieve Tesla-like investment returns over time and reach mega-cap business valuations, investors should look for stocks that are relatively small, pioneers in the markets they operate in, and that have customers who love their service.
I own Teladoc, Sea Limited, and Cloudflare -- and have no plans to sell as they have plenty of potential still left in them to produce Tesla-like returns.