Massive Growth!

My apologies, but that's really how the fax read. It was a pitch for a penny stock. I'm not going to mention the name, because I don't see this company as legit. Lucky thing, too. The stock is down more than 70% from when I first received the fax in early March.

I hope your portfolio will never be touched by a scam like this. But hope alone may not be enough to avert disaster. Indeed, there's a very fine line between a stock scam and informed speculation. Let's deconstruct my spammer's pitch so you'll know which is which.

The hook
Every piece of stock spam you receive will try to establish credibility immediately. Here's how the huckster pitching me did it:

HYPE INC. is a unique INVESTMENT OPPORTUNITY that is positioned for significant share price appreciation, with realistic financial forecasts projecting rapid revenue growth and high-net profitability.

We are able to identify stocks just before Wall Street gets word of them in turn enabling our members to make significant profit gains. Our last recommendation on GARBAGE INC. back in December 2005 helped our subscribers realize a gain of over 450% in their portfolio.

Here are the clues this is a scam:

• There's no such thing as "high-net profitability."
• Wall Street may ignore some stocks, but it certainly is not unaware of them.
• That 450% return looks great. But that same stock has since lost nearly 50% of its value.
• There's no record of this so-called membership firm or its scorecard anywhere on the Web. You're taking this "gain" entirely on faith.

The so-called proof
The best pitches also include some sort of proof that attempts to show the firm is sustainable. Here's how it went in the fax to me:

FINANCIAL PROJECTIONS

HYPE INC. is positioned for explosive growth in the coming five years and beyond. Our realistic assumptions are based on selling 100 franchises in 2006, 300 in 2007, 600 in 2008, 1,000 in 2009, and 1,500 in 2010. This would be similar to the historic growth figures for CREDIBLE COMPANY. Under this scenario, total revenue would increase from $2.7 million in 2006 to $59.5 million in 2010.

The clue that this is a scam: 85% compound annual growth over five years is rare. Even Starbucks, a superior growth story, averaged just 65% annual revenue growth in its early stages.

The fine print
Of course, there's other flawed logic, but you get the point. Let's move on to the fine print, where the scam is revealed:

Compensation: TRYING TO BILK YOU INC. shall be paid $182,000 for the marketing of this publication from a third-party affiliate of HYPE INC. There is an apparent conflict of interest since third party may sell stock in the open market. [Emphasis mine.]

Un-freaking-believable.

The reality
It's a sad truth that some people out there are trying like crazy to get you to buy into high-growth stories that make no sense. It's sadder still that these hucksters reflect really poorly on growth as a strategy. I know some investors who eschew growth entirely because of the spam they receive. Don't let that be you, Fool.

After all, these scams work because massive sales growth really can be a great indicator of outsized returns. But you needn't go to the pink sheets to get it. Here's a list of seven firms that trade on a major exchange. Each grew revenue by more than 50% annually over the past five years:

For the record, the S&P 500 is up a little more than 20% over the past five years (including dividends).

Break the rules, not your portfolio
But that's no surprise, right? Growth investors have trounced the market for decades. T. Rowe Price and Philip Fisher come to mind. And, to a lesser degree, David Gardner. His Rule Breaker style seeks legitimate businesses with sustainable advantages, talented and committed managers, and growing legions of customers. That's why, over a 10-year period, the real-money Rule Breaker portfolio generated average returns in excess of 20% annually. And its successor, managed by David and his team at Motley Fool Rule Breakers, has identified four multibaggers in less than two years. Want to know what they are? A 30-day all-access pass will get you the answer. It's free, and there's no obligation to buy.

This article was originally published on March 31, 2006. It has been updated.

Fool contributor Tim Beyers only breaks the rules in his portfolio. Wimp. Tim didn't own shares in any of the companies mentioned in this story at the time of publication. You can find out what is in his portfolio by checking Tim's Fool profile . Starbucks is a Stock Advisor recommendation. The Motley Fool has an ironcladdisclosure policy.