We know from four years of confirming research by my Foolish colleague Tim Hanson that the best stocks to buy and hold for the long term begin as ignored and obscure small caps.
But that can't be all there is. Any micro cap can be small and ignored. And not all well-managed, cash-conscious small caps make for multibagger returns. Just ask me about Secure Computing some time.
"There has to be something more to the very best of the best," I thought when studying this year's list. So I didn't stop there. I revisited the market's 10 best for the decades ending in 2005, 2006, and 2007.
What I found might help you to crush the market.
Here's what I found
Eight stocks made Tim's list more than once, including clothier Comtech Telecommunications
And not just any four-peat. Hansen has topped Tim's list every year. The investor lucky enough to have bought $10,000 worth of this stock on Jan. 3, 1996 would have roughly $3.4 million today.
What made Hansen so special? Growth. Sexy, beautiful, ginormous growth coupled with very high returns on capital:
|
Year |
Revenue Growth |
ROC |
|---|---|---|
|
Trailing 12 mos. |
12.1% |
24.8% |
|
2007 |
49.3% |
44.1% |
|
2006 |
73.6% |
56.4% |
|
2005 |
93.5% |
69.8% |
|
2004 |
63.4% |
45.5% |
|
2003 |
19.9% |
18.1% |
|
2002 |
14.1% |
10.4% |
|
2001 |
12.5% |
10.9% |
|
2000 |
(0.8%) |
16.5% |
|
1999 |
34.2% |
26.1% |
Source: Capital IQ, a division of Standard & Poor's.
The secret of a millionaire-maker stock
Management's decision to enter the market for "functional beverages" like energy drinks in April of 1997 may have been the catalyst. Interestingly, it wasn't the first to do so. Austria's Red Bull was an established leader in Europe and was winning customers here when Hansen entered.
But the U.S. was an emerging market for functionals. And Hansen CEO Rodney Sacks found an edge over Red Bull. His team focused on the taste, branding, and distribution of its flagship Monster Energy drink. Hansen differentiated itself from Red Bull and other competitors by blending its energy drinks with citrus-flavored fruit juice, introducing large cans with a hardcore look to appeal to younger customers, and utilizing unconventional promotional tactics like giving away free samples at convenience stores and sponsoring X Games athletes.
Buzz followed. Then, orders. Lots and lots of orders.
Hansen, in other words, helped shape a new multi-billion-dollar category early in its development. Fool co-founder David Gardner has a name for firms like these: Rule Breakers.
I had my answer. The best stock of the decade, four years running, was more than just small, obscure, and ignored. It was also a rebel.
How to find today's best
I take three lessons from this narrative:
- High growth is best when coupled with high returns on capital.
- The very best small stocks are the ones creating new industries.
- You don't have to rush to buy the biggest winners.
Indeed, you could have waited until 2 years after Hansen's functionals rollout to buy and would still have enjoyed the largest multibagger of the last 10 years.
Today's investors have the same opportunity. Each of these five small caps is like the Hansen of a decade ago -- growing fast and known for effective capital allocation:
|
Company |
2-Yr. Revenue Growth |
2-Yr. Est. Revenue Growth |
Return on Capital |
|---|---|---|---|
|
Advanced Battery |
52.2% |
171.2% |
18.7% |
|
ClickSoftware Tech. |
23.9% |
29.1% |
22.8% |
|
Genoptix |
108.3% |
99.8% |
17.2% |
|
Perfect World |
196.4% |
64.1% |
31.3% |
|
Under Armour |
28.2% |
24.5% |
15.2% |
Source: Capital IQ, a division of Standard & Poor's.
Interestingly, Under Armour is already a pick of David's Motley Fool Rule Breakers service. I mention this because, in my screening for the next Hansen, Capital IQ found that 9 current Rule Breakers picks passed my tests, which were:
- Listing on a major U.S. exchange.
- A market cap greater than $150 million.
- Historic revenue growth above 15% over the past 2 years.
- Current ROC above 15%.
- Estimated revenue growth above 20% over the next 2 years.
The bad news? Some low-rated stocks also qualified, including Allegiant Travel Company
Obviously, it takes more than a good screen to find rebel stocks. That's why David's team goes six-deep. We depend on each other to go beyond the financials and study the likelihood of disruptive change occurring.
Care to learn more about the process? Click here for 30 days of free access to Rule Breakers -- you'll get unfettered access to all of our research, as well as our team's five top growth stocks for new money now.
This article was originally published Jan. 23, 2009. It has been updated.
Fool contributor Tim Beyers didn't own shares in any of the companies mentioned in this article at the time of publication. Tim is a member of the Rule Breakers team, which counts Under Armour among its recommendations. Under Armour is also a Motley Fool Hidden Gems recommendation. The Motley Fool owns shares of Under Armour and has a disclosure policy.
