I have to tell you, for the most part, we get a great response at conferences across the country. I thoroughly enjoy speaking with both educated and novice investors alike. Today however, we start with a direct response from an article I recently authored on how to select great “long-term” growth stocks: “if they can’t’ tell you what will go up 100% in the next couple of days them guys (the research team at KeyStone) are useless and suck at picking stocks.”
Grammar issues aside, this type of get-rich-quick mentality scares the bejesus out of me.
Now, don’t get me wrong. I enjoy the fine art of stalking monster returns. Heck, I’ll even reveal your best shot at snagging the proverbial 10-bagger a little later in this piece. But first, let me warn you against an investing mistake that leads to many down quite the opposite route – towards a zero-bagger.
Fair Warning
My worst investing decisions have involved three common elements:
• The “need” to act quickly.
• The allure of unlimited upside.
• A lack of serious due diligence.
Visions of massive short-term unrealistic profits lead to hasty decision-making, which leads to losses. In other words, almost every time I’ve tried to swing out of my shoes to hit a home run, I’ve struck out.
To defend yourself against the kind of greed that leads to grief, put investing returns in perspective.
The critic above was looking for 100% returns in just a few days. Let’s put that in context for a minute. If you started with US$10,000 and made 100% gains even every week, you’d be the richest person in the world — surpassing Bill Gates’ approximate US$80 billion – in far less than six-months. Sounds pretty reasonable – NOT!
Let’s go one step further. Perhaps you’re thinking of the huge gains we’ve had over the course of the last year or even in the first 2-months of 2015. Our 2014 top rated specialty pharmaceutical company, Cipher Pharmaceuticals Inc. (CLH:TSX) has gained over 100% and, in the last 2-months alone, our top rated Canadian Small-Cap Software developer has also gained nearly 100%.
Although these are real returns some clients have achieved, they’re not the sort of realistic gains (on average) anyone can expect over the long term. Folks, it would be silly to extrapolate Usain Bolt’s 100-meter times to conclude that he could run a marathon in 70 minutes. Similarly, even the best investors can’t generate 100% returns year-after-year.
What’s the upper limit of reasonable?
Peter Lynch is recognized as one of the greatest investors of all time. The widely followed investment guru ran Fidelity Magellan Fund from 1977 to 1990 — less than 15 years, during one hell of a bull market. Even in those perfect conditions, he “only” averaged 29% annual returns.
How about Warren Buffett? His returns are lower than Lynch’s (albeit over a longer period and with larger amounts of capital). If you got in on his company, Berkshire Hathaway, in 1965, you’d have generated average annual returns in the neighborhood of 20%.
Now, because of the power of compounding for 45 years, those returns are tremendous. A $10,000 investment back then would leave you a millionaire many times over.
Believing you can do much better than the 20% to 30% long-term annual returns of Lynch and Buffett is almost surely a road to overconfidence and failure. Remember, doing half of what they did can make you a very, very rich investor.
Your best shot at a 10-bagger
Now that we’re grounded in reality, let’s talk about what it takes to snag a ten bagger over the next 10-years, while limiting your risk.
To show you we are not just whistling Dixie, I have provided examples of three stocks KeyStone recommended that not only achieved the elusive “10-bagger” status, but hit rarified air at the 20+ bagger level.
The first, Hammond Power Solutions (HPS:TSX), was recommended at $0.62 in February of 2002. Just five years later in 2007, we sold the manufacturer of custom electrical-engineered magnetics and electrical dry-type transformers, when the company’s shares traded at $13.10 – a 2,012% return.
The second, WaterFurnace Renewable Energy Inc. (WFI:TSX), was originally recommended in January 2001 at $1.15 and subsequently purchased for $30.60 per share in 2014. The company, a leading manufacturer of residential, commercial, industrial and institutional geothermal and water source heat pumps, produced a whopping gain of 2,561% (not even including dividends)!
Finally, the latest edition to our 20-bagger club, The Boyd Group Income Fund (BYD.UN:TSX), which we originally recommended to client in November of 2008 at $2.30. Boyd, a simple car repair business that has grown to become one of the largest independent shops in the U.S, has seen it shares rocket to recently close at $46.70. In fact, over that period the company has created such strong cash flow it has distributed over $2.20 per share in distributions (dividends) to shareholders on top of the tremendous share price gains. Again it has paid us $2.20 in cash and we bought the shares for $2.30! That is a gain of over 2,000%!
Satisfied that we have some experience in this area? Ok, now for a stock to be worth 10 times its buy-in price in 10 years requires a 26% annual return. As the returns of Lynch and Buffett attest, that’s huge!
Going after that kind of return, even in an individual stock, isn’t for everyone and you should have a higher than average tolerance for risk. But, it does not mean you should be taking “undue” risk.
For those of us who want to pick some individual stocks and go after a 10-bagger or two, small-cap stocks (i.e., stocks with market caps of $1 billion (Canada) or less) are our best shot.
Large-cap stocks like Wal-Mart Stores Inc. (WMT:NYSE) ($267 billion market cap) and Cisco Systems, Inc. (CSCO:NASD) ($148 billion market cap) simply don’t have the room to grow that their $1-billion or $500 million-and-under brethren do. Now, large caps have their place in your portfolio, but that place isn’t in the area dedicated to the 10-bagger.
To maximize your chances of achieving a 10-bagger in 10 years without throwing Hail Mary’s, focus on smaller companies that have:
• Excellent balance sheets (high net cash positions).
• Strong cash flows.
• Strong growth prospects.
• Trade at reasonable valuations given the above.
Since the start of 2015, our small-cap experts in the KeyStone’s Small-Cap Research Department have selected 6-new stocks. All have already produced gains with one stock up in the range of 100% and another over 50%. If you want to find a potential 10-bagger, start with these stocks and employ our “Focus BUY” Strategy. While there are not many out there, it is our job to find them. Adding 10-12 of these to your portfolio over the next year is your best chance at finding the “next one.”
When building your Small-Cap Growth Stock Portfolio, we suggest you follow the following simple steps.
- Purchase between 10-12 Small-Cap Stocks and equally weight each selection initially. For example; $100,000 portfolio with 10 stocks would allocate $10,000 per stock.
- Construct your portfolio over at least a year period – ensuring you do not buy at a market peak within a year or cycle.
- We recommend companies from a diverse set of industries allowing you to achieve our focussed level of diversification.
- Review and pay careful attention to our updates and use our continuing research to guide your decisions to BUY, HOLD, or SELL given your time horizon and tolerance for risk.
Remember, you do not need to buy many stocks that achieve this level of success in your entire investment lifetime to put an overwhelmingly positive light on your investment career. They can also allow you to make a few mistakes along the way as we all do.
3/3/2015
IP COMPANY REPORTS SOLID 2014 EARNINGS, WEAKER OUTLOOK FOR Q1 2015 – RATING DOWNGRADED
