“How would you like to make 10x on your investment?”
Ordinarily, you and I would respond with deep skepticism. Such questions are usually followed by a multi-level marketing () pitch, a link to a questionable Western Union account, or both.
(Hang on while I tell this West African prince that I’m busy).
But when it comes to the stock market, 10x gains do happen… even if only occasionally.
Since 2016, 22 companies of the Russell 3000 have risen such an amount, according to data from Thomson Reuters.
$10,000 invested in these firms would be worth $190,000 today.
And over longer periods, plenty more companies make the cut. Of the 500 companies in the S&P 500 index, 137 have gone up 10x since 1990.
So, how can investors find these moonshots without risking the farm?
The Power of High Growth Rates
Consider the stocks that have bested the Russell 3000 since 2016.
- Enphase Energy (NASDAQ:ENPH). +83x
- Advanced Micro Devices (NASDAQ:AMD). +35x
- Immunomedics (IMMU). +27x, acquired by Gilead Sciences (NASDAQ:GILD) in 2020
- Lantheus Holdings (NASDAQ:LNTH). +25x
- Nvidia (NASDAQ:NVDA). +23x
These companies have several elements in common:
High Estimated Earnings Growth. The median 10x company had an estimated growth rate of 39% at the time, compared to 20% for 5x picks and 12.6% for all shares.
Low Margins. Return on Capital Invested averaged 6%, compared to 9.7% for all stocks. Net income margin of 3.8% was also lower than the 5.8% median.
High Earnings Quality. Except for Plug Power (NASDAQ:PLUG) and Tesla (NASDAQ:TSLA), these 10x companies earned high scores in their ability to convert revenues into cash flow, as measured by Thomson Reuters’ StarMine model. As a group, they average a score of 68 — well above the 50-point median.
These are elements you would expect from hypergrowth companies. Management teams that are willing to sacrifice near-term earnings for growth…
…while juggling a solid, cash-generating business at the same time.
But running the formula in reverse doesn’t necessarily yield good results. Taking the top 10% EPS growers in 2016 would have returned only 37.1%, not much different from the 37.6% of the broader market. And selecting the companies with the lowest decile of net margins would have lost investors 13%… a poor showing indeed.
The ‘X’ Factor of 10x Stocks
So, what separates these high-returning companies from those that fizzle out?
Though many theories exist, an examination of the 22 stocks that rose 10x since 2016 reveals one commonality:
Almost every company existed in a growth market.
Nine of the firms were info-tech related, including Digital Turbine (NASDAQ:APPS), Etsy (NASDAQ:ETSY) and Paycom Software (NYSE:PAYC). Another six concentrated in renewables or clean energy, and four focused on healthcare.
In 2016, these sectors represented some of the fastest-growing areas of the American economy. Firms like Nvidia and AMD would ride a massive wave of chipmaking and AI applications to become top performers. Lantheus Holdings and STAAR Surgical Company (NASDAQ:STAA) would do the same in healthcare.
Meanwhile, only one deep value play made the list – iron mining firm Cleveland-Cliffs (NYSE:CLF). The firm narrowly escaped bankruptcy in 2016, but continues to trade 85% below its peak in 2008.
It’s why of the 10 stocks I covered that could rise 10x, eight of them exist in high-growth areas…
- Desktop Metal (NYSE:DM): 3D printing.
- Ginkgo Bioworks (NYSE:DNA): Bioengineering.
- SoFi (NASDAQ:SOFI): Fintech
- RealReal (NASDAQ:REAL): Discount e-commerce
- POSaBIT Systems (OTCMKTS:POSAF): Legal cannabis
- Upstart Holdings (NASDAQ:UPST): Cloud-based AI lending
- Shoals Technologies Group (NASDAQ:SHLS): Solar
- Gentex (NASDAQ:GNTX): Autonomous driving.
…and none are deep value plays.
Finding the Next 10x Winner
If this seems like a lot of information, I get it. Finding 10x stocks can seem like searching for a needle in a haystack of Ponzi schemes.
Promising companies like crypto exchange Voyager Digital (OTCMKTS:VYGVQ) can seem like the next best thing…
…right until they declare bankruptcy and make billions of investor dollars disappear.
And even firms that do go up 10x can often remain there only temporarily. My stock pick of Longeveron (NASDAQ:LGVN) managed to rise 10x on a meme stock frenzy, only to settle back at a 2x return.
That’s why investors should focus so heavily on cash-earning companies. Firms like Gentex generate 11 cents of free cash flow for every dollar of sales. And some like blue-chip cybersecurity firm CrowdStrike (NASDAQ:CRWD) do even better.
Finding stocks that will rise 10x is still risky at best. But following some tried-and-true methods can help your chance at landing a home run.
Tom Yeung is a market analyst and portfolio manager of the Omnia Portfolio, the highest-tier subscription at InvestorPlace. He is the former editor of Tom Yeung’s Profit & Protection, a free e-letter about investing to profit in good times and protecting gains during the bad.