During his time with the Fidelity Magellan fund, Peter Lynch made a fortune on profitable businesses with growth engines attached to them -- that is, companies with high sales-growth rates and great margins. Taco Bell, Pier One (NYSE:PIR), and Dunkin' Donuts are some of his more famous picks that fit this description.
High-growth companies, however, can be particularly susceptible to short-term volatility if their earnings reports or quarterly growth figures miss analyst estimates. When these short-term overreactions occur, it can be a great time to buy and rack up a fortune.
Take the turbulent year Coach (NYSE:COH) had in 2006, for example. It lost more than 20% between Jan. 1 and mid-July amidst a broad sell-off of retail stocks by investors concerned about the state of the American consumer. Despite all this, Coach maintained strong margins (in terms of earnings before interest and taxes) and grew revenue 23% year over year.
Once the market came back to its senses, and worries about U.S. consumer spending faded away, Coach shares surged -- up 70% from their mid-July lows.
One-trick pony?
Coach isn't the only retailer to have been unfairly cut down this past year.
Just this past fall, shares of drug retailers including CVS (NYSE:CVS) and Walgreen (NYSE:WAG) fell sharply after Wal-Mart announced that it would begin offering $4 generic drugs. Even though panicked investors sent their shares downward, CVS and Walgreen went about business as usual, maintaining strong margins and growing revenues. The market soon realized it had overreacted -- Walgreen is up 15% and CVS 14% since the end of November.
On the flip side, when a company's sales are weak and its margins are contracting, its shares can get knocked down for the count. Look at what's happened to Hot Topic (NASDAQ:HOTT), Talbots (NYSE:TLB), and Foot Locker (NYSE:FL) over the past few years.
Making a fortune off mistakes
When searching for great buying opportunities, look for strong companies that the market has treated unfairly. One way to do this is by looking for companies that sustain solid growth rates and margins even during down markets.
Motley Fool co-founders David and Tom Gardner often use this same strategy to find stocks that will beat the market for their Stock Advisor investing service. Altogether, Stock Advisor picks are up 68% on average since March 2002, compared with the market's 29%.
And yes, there are some retailers on the list -- including two with great growth histories that are suffering from temporary difficulties.
To see all of their Stock Advisor picks and research, follow this link for a full-access, 30-day free trial to the service.
Todd Wenning does not own shares of any company mentioned. Wal-Mart is a Motley Fool Inside Value pick. The Motley Fool has a disclosure policy.
