In my experience stocks with a reasonable chance of doubling over a period of, say, three to five years, have things in common. Let's analyse 10 signs to watch out for.
1. Out of favour. This is potentially a value investor's most financially rewarding situation - a stock that's out of favour and, with any luck, even hated. Many of our most lucrative investments have risen from the depths of despair.
Take Cochlear for example. In 2004 its woes included a change of chief executive, two profit downgrades, and an inquiry into its selling practices by the US Department of Justice - all within a 10-month period. The share price fell below $20, but eventually climbed above $80. Following the recent recall, could it double again?
2. Hidden progress. Often a business's progress will take some time before revealing itself in the financial statements. Macquarie Bank couldn't do a thing right in 2002 according to the media. But an astute understanding of the bank's lucrative management fee model revealed it contained significant underlying growth that almost caused its share price to reach $100. With the market currently fixated on Europe, is Macquarie being underestimated again?
3. New technology. In certain industries companies can generate significant cost savings by introducing new technology. We recommended Cabcharge in 2003 partly because it was improving its operating margins with the implementation of electronic payment systems in taxis. This former market darling has also found itself out of favour recently.
4. Investment in R&D. The benefits of undertaking research and development and investing in specialist skills can take years to manifest themselves. Philip Fisher, in his book Common Stocks and Uncommon Profits, suggests that the best companies to buy are those investing heavily in R&D today to provide the profits of the future. Healthcare device manufacturers such as Cochlear and ResMed are following this path.
5. Industry tailwinds. Many investors have struck gold with resources stocks benefiting from the emergence of China and India as rapidly industrialising nations. That has added significantly to world demand for a wide range of commodities, such as oil and iron ore. The recent falls in prices of resources stocks and commodity prices could provide opportunities.
6. Changes in industry structure or the number of competitors can provide opportunities for the remaining businesses. Coates Hire was one we missed many years ago, when its acquisition of Wreckair removed a competitor and helped consolidate the industry just as the resources and construction boom began.
7. Owner-managers. Then there's the owner-manager effect, with the most successful companies run by business builders with their own money on the line, like Gerry Harvey of Harvey Norman. And then there are the company-men with long and successful track records like Brian McNamee at CSL. Time and again, the stocks that double do so because the company has exceptional management.
8. Insider buying. While a strong leader with a vested interest in performance is a big positive, so is evidence that directors are buying the stock for their own portfolios. While there are many reasons why an insider might sell, there is generally only one reason they buy in meaningful amounts. They believe the stock will go up.
9. Financial strength. Flimsy balance sheets indicate weakness and invite disaster. Leighton used to boast a very strong financial position as it operates in a very cyclical industry. That allowed it to withstand the pressure of lean years and prosper in the fat ones. More recently, though, it was forced to raise capital after writing off assets and using debt to expand overseas.
10. Unrecognised by the market. Finally, look for quality companies that are simply unrecognised. With around 2,000 listed stocks, there will always be opportunities for investors to uncover rough diamonds.
See? It's that simple. But it isn't really is it? Without genuinely independent thinking and a thorough understanding of the facts as you see them, even finding appropriate stocks is difficult, let alone having the courage to take advantage of opportunities when they present themselves.
But that's what value investing is all about. You have to be ruthless about where you spend your time, but success is all the sweeter when your homework uncovers a gem.
This article contains general investment advice only (under AFSL 282288).
Nathan Bell is research director of Intelligent Investor.
Read more: http://www.brisbanetimes.com.au/business/10-signs-your-stock-will-double-20111025-1mhax.html#ixzz1bmZEuPfP