In the past, I've mentioned in this space our eternal efforts to uncover small companies that will eventually appreciate many times in value. The legendary Peter Lynch called such companies "multi-baggers," and they are the real difference makers in a lifetime of investing -- the ones that easily make up for mediocre and failed investments.
Just ask anyone who invested in Amgen
Today, I thought I would look at Audible, and why it turned into a seven-bagger for me over a 14-month period. Perhaps we can learn why it achieved in that short period what it takes an index fund about two decades to reach at historical market growth. We love indexing, and we think it should be a core part of your portfolio, but Audible offers a great example of how small-cap investing can really juice your returns.
Hear me now
Audible is the No. 1 provider of spoken-word content on the Internet. Besides audio books, it also provides daily newspaper and magazine articles, interesting speeches, and various other nifty things. Users can download the content to listen via encoded MP3 files on their portable player, burn the audio onto a CD, or just listen on their computer. Think of how handy it would be to listen to The New York Times or The Wall Street Journal on the way to work every morning!
In typical Lynchian fashion, I was a loyal Audible customer before I thought about the company as an investment. I commute to Fool HQ 30 minutes each way, and in 2000 I found that Audible's audio books not only made that time on the Capital Beltway fly by, but that they also educated, amused, and enriched me in ways I would never have imagined.
When I started, a $14.99 monthly fee allowed me to download two books each month. I was able to catch up on things I should have read long ago but never had the time. The Hobbit motivated me to read the entire Lord of the Rings trilogy. Jeffrey DeMunn's narration of Stephen King's Dreamcatcher was outstanding. Ernest Hemingway's The Old Man and the Sea was short but sweet. Atlas Shrugged, Ayn Rand's 55-hour epic, was not short. I would never have discovered such gems as Ender's Game and Life of Pi if it weren't for Audible. All "told," nearly 100 books have passed through my now-ancient Rio 500 MP3 player and into my head.
The great tech wreck saw companies like JDS Uniphase
In September 2003, I bought in at $1.14 per share (pre-split). This was before I joined the Hidden Gems team, and, unbeknownst to me, Tom Gardner placed it on his Gems Watch List in the October 2003 issue, citing a move toward positive free cash flow, non-dilutive management, top-line growth, and other improving fundamentals.
Since then, we've seen four straight quarters of positive cash from operations, the first quarter of GAAP profitability, a reverse stock split (which raised my cost basis to $3.50 per share), a relisting on the Nasdaq, and a deal with Apple to get content in the iTunes Music Store and to make the hot-selling iPod players "Audible-ready," as well as deals with Dell, Gateway
Also, investors have come to realize the potential of Audible's distribution system. Netflix CEO Reed Hastings has mentioned Audible as one of the small companies he most admires. I can't help wondering how much more efficient and profitable his business would be if it didn't have to mail out all those DVDs. One day, when broadband becomes even broader and other technology is in place, Netflix and competitors like Blockbuster and Wal-Mart will be able to distribute movies the same way Audible offers books. Perhaps Audible, with its first-mover expertise, will even have a hand in it all.
My point here is not to extol the virtues of Audible. By all standard measures, it's now a very pricey stock and certainly out of Tom's buy-in range. It is no longer a value play. And it's volatile; since I originally wrote this column, it turned into my first eight-bagger, dipped a tad below a seven-bagger, and is now back up again near eight-bagger status!
Don't get me wrong; I believe in the company's future and will continue to hold all or part of my position. I simply understand that it's still a high-risk investment that may fluctuate wildly in the months (and years) to come. GE
I think it's instructive to look back at some of the characteristics that made Audible a Hidden Gem in the first place:
- After a period of decline, accelerating sales growth
- High inside ownership
- Non-dilutive, shareholder-friendly, dedicated management
- Strong price appreciation potential based on Tom's valuation method
- Underfollowed and unloved
When we find companies like this at Hidden Gems, we become very interested and dig deeper, making sure that all the pieces of the puzzle fit together. And the results so far have been excellent. If you're interested in our approach and want to receive two stock recommendations each month, Tom is offering a special 30-day free trial.
This article was originally published on November 19, 2004. It has been updated.