In the past, I've mentioned our eternal efforts to uncover small companies that will eventually appreciate many times in value. The legendary Peter Lynch called such companies "multibaggers," 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 Starbucks (NASDAQ:SBUX) after its initial double in 1993 and saw his or her investment eventually soar by more than 2,000% before the stock's recent drop (though it's still up more than 600%). Or how about those who saw the early promise in companies like Oracle (NASDAQ:ORCL), Cisco (NASDAQ:CSCO), and Intel (NASDAQ:INTC)? A $5,000 investment in each in 1993 would be worth more than $180,000 today.

All of these companies gave hints of a bright future. In Motley Fool Hidden Gems, we look for such unknown or unloved businesses, and even those that most investors consider broken.

Today, I thought it would be interesting to look at Audible, and why it turned into a seven-bagger for me over a relatively short period. It's especially interesting now, because the stock took several big swings since this column first ran more than three years ago, and the company was finally bought out by Its story 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 players, burn it onto CDs, or just listen on their computers. 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 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 for. 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," more than 100 books have passed through my now-ancient Rio 500 MP3 player and into my head.

Barely audible
When I looked at the company as an investment possibility, the stock was below $1 per share, down from the $45 range after its 1999 IPO. The business had never been profitable and was in danger of running out of money and closing its doors. It was too risky for me then, but I kept an eye on it. Over the months, things began to stabilize somewhat. Sales growth, after decelerating from 1999 through 2002, began accelerating again. The stock price doubled from its lows. There were still many obstacles to overcome, but -- because of the strength of the product, high inside ownership, and the dedication of Chairman and CEO Donald Katz -- I believed the company would get past the bad times and flourish.

In September 2003, I bought in at a pre-split $1.14 per share. This was before I joined the team, and unbeknownst to me, Tom Gardner placed it on his Hidden 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, the company has rolled out 16 out of 17 quarters of positive cash from operations, 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." There were also MP3 players from SanDisk (NASDAQ:SNDK), Dell (NASDAQ:DELL), and others -- and each owner is a potential Audible customer. The stock price reflected all that good news, ending with the Amazon buyout.

A Gem dandy
Amazon paid $11.50 per share for Audible, so I was well pleased with the final return on my investment, rocky though the ride was. I think it's instructive to look back at some of the characteristics that made Audible a Hidden Gems Watch List selection in the first place:

  1. After a period of decline, accelerating sales growth.
  2. High inside ownership.
  3. Non-dilutive, shareholder-friendly, dedicated management.
  4. Strong price appreciation potential based on Tom's valuation method.
  5. 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. All told, Gems selections have outperformed the S&P 500 by an average of over 10 percentage points.

If you're interested in our small-cap approach and want to receive two stock recommendations each month, we're offering a special 30-day free trial.

This column was originally published on Nov. 19, 2004. It has been updated.

Rex Moore is currently listening to The Curse of Chalion, by Lois McMaster Bujold. He owns no companies mentioned in this article. Starbucks, Intel, and Dell are Motley Fool Inside Value picks. Starbucks is a Stock Advisor recommendation. The Fool owns shares of Starbucks and has a disclosure policy.