Stock Advisor Buy List: Boston Beer Co.

At Motley Fool Stock Advisor we're about finding stocks with huge long-term upside. Our research efforts double-down on a company's growth potential, competitive advantages, and management quality. It's a strategy that's led to an average return of 58% for our stocks and 14% annualized returns since 2002, versus 1% for the S&P 500.

Let's see why Boston Beer Co. (NYSE: SAM) currently makes our buy list.

Growth potential
Even if you don't already know the brand, you might have guessed from its ticker symbol that Boston Beer is best known for its Samuel Adams line of brews. Including its flagship Boston Lager brand, there are more than 20 beers under the Sam Adams label. (Summer Ale is my personal favorite, but my tastes, along with Boston Beer's brewing schedule, tend to change with the seasons. There's just nothing like a rich Sam Adams Winter Lager when the temperature turns colder.)

Boston Beer is the leading U.S. brewer of "better" beers, which include craft beers, specialty beers, and most imported beers. They account for about 20% of total U.S. beer consumption and are defined by higher quality, taste, image, and, in most cases, price. Last year, the craft brewing category grew 5%, while the overall beer market declined between 1% and 2%, and is expected to get even bigger as consumer preference for higher-quality beer grows.

Let's take a quick look at Boston Beer's last five years of results.

Source: Capital IQ.

Sales have grown at a nice 12% annual clip, while operating profits, despite a hiccup in 2008 (more on that below), have more than doubled over the past five years. That's impressive growth for sure. Yet, in our opinion, Boston Beer is just getting started.

If you've caught any of the recent Sam Adams commercials (and there are some good ones), Boston Beer makes it known that despite its growing market penetration and brand appeal, it still accounts for less than 1% market share of the U.S. beer market. The U.S. market is wide open and we haven't even begun to talk about Sam's potential in overseas markets.

Competitive advantages
Still, Boston Beer is a very small fish in a very big pond. And that pond happens to include a few gigantic whales. Anheuser-Busch InBev (NYSE: BUD), Molson Coors (NYSE: TAP), and SABMiller collectively comprise 94% of total U.S. beer production. That means the big boys also control distribution, making it tougher and more costly for Boston Beer and other small brewers to get shelf space at the local liquor store, or tap space at your favorite bar. And of course, major foreign brands such as Corona from Constellation Brands (NYSE: STZ), Heineken, and Diageo's (NYSE: DEO) Guinness are also competing for U.S. customers' dollars and palates.

Being small also hinders a craft brewer's ability to exert pricing power with its suppliers or fully control production. A worldwide shortage of hops in 2008 caused a big spike in Boston Beer's brewing costs. But an even bigger hit to its profit came from a massive recall of defective glass bottles supplied to its Cincinnati brewery. Ultimately, the company had to recall nearly 1 million cases of beer and spend nearly $23 million to clean up the mess. For big brewers, these problems can amount to a drop in the bucket, but they can make or break a small brewer.

Fortunately, with the addition of its new Pennsylvania brewery, Boston Beer now fully controls its production and can focus on where it does have a bit of a competitive edge right now: its brand. According to CEO Jim Koch, the major brewers have spent nearly 25 years trying to break into the craft beer market, with only one notable success: Blue Moon from Molson Coors and SABMiller. Boston Beer has established a serious brand following -- enhanced by Koch's big personality and clever commercials -- that we think is only going to get bigger.

Management quality
That leads right into Boston Beer's perhaps more important asset and competitive advantage: Koch himself. In 1984, he left a lucrative consulting career to chase his dream of brewing the world's best-tasting beers. Samuel Adams Boston Lager, an old Koch family recipe, was born.

From just 500 brewed in its first full year of operation, Boston Beer now brews more than 2 million barrels and has a market value of nearly $1 billion. Koch still owns more than 30% of the shares, appears in many of the company's commercials, and is famous for sampling every new batch of Sam Adams brewed at its Boston location. But he also runs a tight ship, evidenced by Boston Beer's excellent returns on capital as a public company.

That kind of performance has gotten plenty of outside attention, and Koch is routinely shrugging off buyout attempts from larger suitors. We expect Koch's big ownership stake and maverick approach to the beer industry will keep this an independent brewer for at least as long as he can raise a glass. That makes Boston Beer a stock we can toast for decades to come.

To get our latest thinking on Boston Beer Co. and access to our current buy/sell/hold recommendations on all 90 companies on the Stock Advisor scorecard, take a free trial of Motley Fool Stock Advisor. In the meantime, let us know what you think of Boston Beer Co. in the comments section below. Does it make your buy list?