With so many stocks to choose from, it’s hard to know which com- panies to add to your holdings. Forget the hype; focus on the num- bers. I have a screen test that all companies (except a maximum of two promising rookies) should pass before being considered for your portfolio:
● The company has revenue of at least $100 million.
● The company’s revenue has grown at least 25 percent each year for the past three years.
● The company’s rate of growth decline does not exceed the rates listed in Figure 10.3, shown later in this chapter.
The $100 Million Mark
The reason I prefer picking companies with $100 million or more of revenue is simple: I’m a chicken. I’m looking for the next Cisco,
140 the big tech score
PARAMETER THISYEAR GROWTHRATE NEXTYEAR
Total market 100 units 5% 105 units
sales
Company’s 90 units 17% 105 units
sales
Company’s 90% 11% 100%
market share
Figure 10.1 Tracking Market Growth and
Growth in Market Share.
not the next bankruptcy. I don’t want a highflyer that’s here today, gone tomorrow. Don’t get me wrong—I’m willing to invest in a great company that isn’t showing any profits yet and probably won’t for a long time, but I’m nervous about slapping down my money for a company with nothing going for it but well-placed hype. You should be, too. Once a company pulls in $100 million or more, it’s clear you’re dealing with more than smoke. That’s why I like to use this number as a starting point.
Revenue Growth of at Least 25 Percent for Three Years Running
A company’s growth is an extremely important thing to look at before investing. However, lots of people get swayed by earnings growth. While it’s nice when a stock goes up in price steadily each year, earnings growth can be a red herring, especially with younger companies.
In the early years, earnings growth can be astronomical, because the company keeps improving its business model. That’s not a sus- tainable thing—you can’t keep improving your business model for- ever. A company worth investing in for the long haul needs to be growing in revenue,and growing a lot.
My target in this book is to teach you how to make 25 percent or more on your stocks per year. With that in mind, you need to find companies that have at least25 percent per year in revenue growth. In general, a company’s stock goes up in relation to its revenue growth. As the company matures and becomes more prof- itable, its earnings growth will actually exceed its revenue growth—
and its stock price can rise even faster.
I’ve used three years as a marker to help you differentiate a temporary (or cyclical) growth situation from a true growth com- pany. A short-term event, like the Asian Crisis discussed in Chapter 3, can lead to misleading numbers. For example, in the midst of a crisis in Asia, a company’s sales might drop drastically. Then, the company might show a temporary spike in revenue growth when conditions in Asia improve. Both changes are due to unusual cir- cumstances, and not true fundamentals.
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T H E C O M P A Q S A G A
I had a very positive call on Compaq in 1992. In fact, I had a very positive call on Compaq for most of the past decade.
It was one of my favorite stocks from September 1992 to Jan- uary 1998. At that time, Compaq made a very questionable decision: It bought Digital Equipment.
In my mind, this was a very bad sign. Despite its lofty stock price, and contrary to the general consensus, I decided that Compaq could no longer be a high-growth company.
Compaq, of course, disagreed. By late 1998 it was fore- casting that its revenue would grow 17 percent during 1999.
I was pretty skeptical. When I put the revenues of Compaq and Digital Equipment together, I realized that for the prior three years, the two companies had averaged a mere 6 per- cent per year in revenue growth. In fact, it was within a point of 6 percent each and every year. I published a report telling people to get out of the stock.
That was in December 1998. By February, Compaq had its tail between its legs. The company admitted that it wasn’t going to meet the numbers it had promised—not a surprise to me, but a big surprise to the people who’d been taking Compaq at its word. Between the announcement and the end of the year, the stock slipped from over $50 a share to
$18. Suddenly, I was interested.
At a sea-level $18, I thought it was a good time for investors to get back into the stock. Why? Because at its root, I believed in the company, and it had finally come back to earth. Compaq’s estimates for 2000 placed growth at about 6 percent—the actual rate of its growth all along. Unlike the company’s crazy estimate of 17 percent, I was comfortable with that.
The funny thing was, I found that most investors like to be lied to. The reason I say that is this: The year before, Compaq was a weak company with a bloated growth fore- cast, and everybody wanted in. In late 1999, it was a stronger company with a more realistic vision of its growth potential,