When it comes to stocks, buying the best – at the right price – is worth it.
There are a lot of ways to make (and lose) money as an investor. Some strategies are very complex. Others are common sense and simple to understand – but not always easy to implement… like the one I’m about to explain.
As a rule of thumb, if you invest in the best company in a dying industry, you’ll probably lose money. You’re fighting the tide and will probably wind up out at sea. And if you invest in an average company in a growing sector, things could go either way. (Of course valuations matter here as well.)
But for the biggest gains, look to exploit the holy trinity of investing:
- Find a sector that is showing exceptional, ongoing growth
- Identify the leading company in this major growth industry
- Buy the leading company when it’s cheap
Here are two examples to show how this works.
Apple shares (NASDAQ; ticker: AAPL) were trading for US$18 in the spring of 2009. And it just so happens that Apple met all three of the investment trifecta at that time:
1) Top Sector: Smartphone use was on the verge of exploding
2) Leading Company: There was no product like the iPhone, not to mention Apple’s other products
3) Cheap Valuation: Despite its growth rate and outlook, Apple stock carried a price-to-earnings (P/E) multiple nearly the same as the S&P 500 – in other words, it was valued the same as an average stock on the S&P 500, even though it was a leading company in a high-growth sector
If you’d bought Apple shares in the spring of 2009 when it met the three growth criteria, you would have made nearly 400 percent over the next three years (compared to the return of the S&P 500 of about 50 percent). And if you held on to the shares until today, you’d be up over 500 percent.
(Of course, “if only” is not a valid investment strategy (as in, “if only I bought Apple share when they were just US$18”). We all have perfect hindsight – and if these decisions were always obvious and easy we’d all be rich.)
100 degrees of Baidu
Another example of exploiting these three growth factors is Chinese search engine giant Baidu (NASDAQ; ticker: BIDU). It’s like the Google of China – and the name in Chinese literally means 100 (bai百) degrees (du度).
In early 2013, Baidu was already China’s top search engine and shares were trading for US$90 each.
But even then, Baidu still met the three top growth criteria:
1) Top Sector: Internet search had been growing steadily for years and forecasts called for more of the same
2) Leading Company: Baidu had long before overtaken Google in China, the world’s fastest growing economy at the time
3) Cheap Valuation: Baidu stock’s P/E (price-to-earnings) ratio had pulled back to 20, a small premium to the market, despite its long growth history and positive outlook
Over the next year and a half, Baidu shares moved up nearly 200 percent.
At the time, Apple and Baidu were not undiscovered gems. They were already giant, successful companies.
While it appeared that their success would continue, at the time their stories felt stale to many investors – some of whom no doubt felt the need to discover new emerging companies to earn a big return. But ignoring the well-run market leaders trading at a reasonable valuation was a mistake.
This easy-to-understand strategy – identify a leading sector, find the leading company in the sector, buy when the stock valuations are cheap – isn’t so easy to execute. Is a high-growth sector slowing down? Has the leading company in the sector lost its way with a misguided strategy or management mistakes? Is the apparently attractive valuation accurately pricing in a slowdown in growth?
How to find big growth companies
The good news is, there are a lot of companies that meet these criteria in Asia at the moment.
We’ll shortly be launching a service focused on uncovering these kinds of stocks… stay tuned for more soon.