Have you ever had one of your investments appreciate by 25 TIMES in just five years? Is that even possible? Well, what I can tell you is that while it may be rare, it definitely is, and in today’s article we’ll be discussing where exactly this happened, when, and what we can learn from it, so that maybe we spot the next one in the future.
These stocks are quite the anomaly and identifying one would be considered the opportunity of a lifetime. One of the greatest investors of all time, Peter Lynch describes these as ‘tenbaggers’, a.k.a. stocks that appreciates 10 times in value, and sometimes more.
Examples of stocks growth on this magnitude are few and far between. So for this one we’ll need to go back to the 90s, to one of the few tech companies that survived the ‘dot com bubble’.
Microsoft
What was the dot com bubble? In 1999, the prices of tech firms soared to unprecedented levels, due to valuations ignoring fundamentals and overhyped stories of future earnings. In 1994, Microsoft was trading at a respectable share price of $2.38. It had been growing slowly and consistently over the past few years. It didn’t stand out from the norm and was not seen as an outlier at the time. However, the late 90s brought a frenzy of activity and hype to the market that hardly anyone could have anticipated.
With the creation of the World Wide Web in 1989, the internet and it’s momentum had been picking up throughout the years, and technology companies were about to ride the wave of a lifetime.
The adoption of the internet combined with the excessive speculation of its possibilities and application saw share prices in tech firms skyrocket beyond belief. 5 years later at the end of 1999, Microsoft, was now trading at a high of $59.38. A growth rate of 25X the investment over 5 years. That’s a 2500% increase.
This article focuses on growth stock opportunities, but if you’re more of a dividend investor, I made an article discussing how dividend investments can actually lead to significant stock growth as well.
Unfortunately, for blue-sky investors that saw the only way as up, they were to be deeply disappointed and shocked. Only 6 months later after the dot com bubble burst, the stock was trading at $31. Since then, Microsoft has maintained itself as an industry leader and is currently trading at $234. So what can we learn from this? Is there anything to take from Microsoft’s meteoric rise and apply it to other growth stocks? First, we need to look at the concept of the growth cycle.
The Growth Cycle
To capitalise on the opportunity of a lifetime, we need to harness the power of the growth cycle. These are the 4 steps every company will experience in its lifetime.
Birth
In the birth stage, a company must successfully enter the market, establish itself by providing its products and services to a growing customer base while building a brand. This can be where the majority of business fail, as they cannot capture a market share or sustain their business operations.
Expansion
In the expansion, this stage can vary in terms of duration, scale and success. In the case of high growth stocks, the expansion phase tends to be rapid. So long as the product or service is scalable enough to meet the demand of the market, these firms can realise significant growth.
We now know that the demand in Microsoft shares was magnified by the speculation around tech firms at the time as ‘the next big thing’. I can’t imagine where we’ve seen wild speculation like this in recent times..!
The question then becomes, is what the investor paying justified, based on the firms earnings? Otherwise known as the Price-To-Earnings (P/E) ratio. This is commonly used in investing to determine whether a company is under / overvalued. In the late 90s, P/E ratios soared to astronomical figures just before the burst, leading to the steep decline.
The market was willing to pay ridiculous sums of money for firms based on their speculative future earnings. Speculation in tech firms could have signalled that earnings were due to grow exponentially, leaving investors to believe that the overvaluation of the stock was somehow justified. This wasn’t quite how it worked out…
Maturity
Once a company enters the maturity stage of the cycle, it’s growth begins to plateau. There could be many reasons for this. Demand for its products or services may not be as high as they were, they may have experienced market saturation, or they could have captured the majority of the market.
High growth companies challenge themselves year-on-year to maintain and exceed the level of growth they previously experienced. But at some stage, there comes a point where they reach a size that they simply cannot grow at the same rate as they previously did.
Do you think Amazon or Apple will continue to grow at historical rates? Reaching maturity doesn’t mean the company is doing anything wrong, but a company at maturity probably won’t give you as an investor the stock opportunity of a lifetime. Where you will want to target is a firm at the beginning of its expansion cycle. The Microsoft of 1994. The Netflix of 2012.
It doesn’t necessarily need to be at the very beginning of the expansion. If you can attain 1 or 2 growth stocks like these as they’re rising to maturity throughout your investment lifetime, you could easily set yourself up for life. As we’ve seen in the examples of Microsoft, Netflix and Amazon, companies that look to radically disrupt the industry they operate in, and completely transform the way we work or consume are ideal growth stock opportunities to pursue.
Decline
To round off the growth cycle we reach the decline stage, where the demand in firm’s products or services declines such that it loses market share. These firms grow to such a scale that they are prone to inflexibility, leading to a lag in their ability to adapt to trends or innovation. It could be that their competition becomes the growth stock we’ve mentioned in this article. They are disrupting these industries, rising rapidly through their expansion phases and putting the big time players out of business? Can you think of any examples?
