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Today, I want to answer the following letter from a reader:
āIām not content with ordinary gains. I havenāt saved enough for retirement and itās causing me anxiety. Iām looking for stocks that can generate exponential gains. What criteria do you use, for finding such stocks?ā ā Jerry B.
Jerry, weāve all heard the lament: If only I had the foresight to buy certain stocks in their infancy, Iād be living on a private island in the Caribbean.
But reliance on technology only partly explains the explosive gains of, say, legendary behemoth Apple (NSDQ: AAPL). Thousands of other companies in the tech sector have not performed nearly as well.
From my perspective, there are four traits that explain a stockās extreme outperformance. The company must be:
- A ādisruptorā in a large market with an established incumbent that is vulnerable to attack.
- Nimble enough to capitalize on the opportunity, with the financial flexibility to access the capital markets while investing for growth.
- āFlying below the radarā of the mainstream financial media, so it can establish a position in its market before the investment herd catches on.
- Inexpensively valued compared to the size of its future market opportunity.
Letās take a closer look at each one of those characteristics and why they are critical to success.
Market Disruptor
The companies that are tapped into constant change prove the most profitable, especially in these tumultuous times. Apple is an instructive case study.
Until Apple came along, the Sony (NYSE: SONY) Walkman was considered a revolutionary breakthrough in portable music. Remember the Walkman?
Appleās iPod was gaining market share as a portable music device, but once Steve Jobs realized that he could add music as an app to a smartphone, the days of the Sony Walkman were numbered.
Not only was Sony unaware of Appleās decision to emphasize apps for its iPhone, but the makers of the BlackBerry (NYSE: BB) cell phone felt equally untouchableā¦until it was too late.
What both of those sector giants failed to realize was that they were vulnerable to attack from below, in this case by Appleās decision to convert the cell phone into a pocket computer.
Financial Agility
Recognizing that a window of opportunity has opened is only valuable if a company is able to act on it quickly. That requires sufficient financial and operational flexibility to implement a comprehensive strategy to capitalize on the opportunity, without blowing up the balance sheet by taking on too much debt or issuing too much stock.
One of the biggest challenges for a small company is acquiring capital at a sustainable cost. If the fledgling firm borrows too much money, the cost of servicing that debt can eventually lead to bankruptcy. But if it issues too much equity, it risks diluting its earnings to the point that its shareholders dump the stock in favor of more attractive opportunities.
Low Profile
Perhaps the most surprising aspect of Appleās assault on Sony and BlackBerry is that it was able to develop its smartphone to very little fanfare.
If something as ubiquitous as the smartphone could go unnoticed during its creation 10 years ago, then tomorrowās breakthrough product or service could be sitting right under our noses today.
I subscribe to the contrarian school of investing. If a āstory stockā is being hyped on financial television, I get suspicious. I prefer to roll-up my sleeves and unearth hidden gems that the lemming-like investing crowd is overlooking.
Mispriced Opportunity
The final condition that must be present for a small company to explode in value is a current share price thatās grossly mispriced compared to the size of the market opportunity.
Focusing on valuation seems like a no-brainer, right? Well, this rule is often ignored. Investors can get excited about a stock that seems too compelling to avoid, even if itās absurdly overvalued.
This truism bears repeating: If a stock is considerably more expensive than its industry or direct peers, or its estimated growth is greatly out of whack with its valuation, stay away.
Editorās Note: Iāve just explained the criteria by which you can find the ānext big thing.ā One industry thatās rife with promising disruptors is marijuana.
As 2023 gets underway, every portfolio should have exposure to the marijuana industry. Thatās why Iāve launched a new service detailing how you can financially benefit from the consumer mainstreaming of cannabis and psychedelics.
Called Marijuana Profit Alert, my publication is your guide to reaping profits from these megatrends. In this service, I provide specific, actionable investment guidance for investors in the booming marijuana and psychedelics industries.
This year, an increasing number of U.S. states (and countries around the world) will legalize cannabis and psychedelics, which in turn will create new markets, new sales, and big profits for the investors who act now.
Want to cash in on the psychotropic revolution? Consider the advice in Marijuana Profit Alert. Click here to learn more.
John Persinos is the editorial director of Investing Daily.
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