Evaluating a stock can be a complex process, but start with the obvious.
It might be hard to imagine any stock becoming a 10-bagger, or gaining 1,000%, in the current market. But you can scout out bargains in any environment. In fact, these might be the best times to see what kind of mettle a stock really has. If it can withstand these kinds of challenges, it might be worthy of your investment dollars.
But becoming a 10-bagger requires more than resilience under stress. If you're looking for the next 10-bagger stock, focus on this one metric.
What makes stocks gain in price?
There are all sorts of reasons a stock price rises, and there might be different reasons a stock price rises in the short term or gains over time. A solid earnings report can affect short-term price movements, or slow sales increases over many quarters can lead to long-term price gains. But historically, what leads to 1,000% price gains is consistently high sales growth.
That may be fairly obvious, but you don't need to look further when thinking about a stock that has the potential to become a 10-bagger. Quite simply, a company that does not have rapidly rising sales isn't likely to explode very quickly -- or in the long run for that matter. Simply put: High sales growth is the determining factor for a high-growth stock.
If you're a long-term investor, it can be difficult to block out the noise that generates short-term price movements. But those newsy factors aren't what usually create 10-bagger stocks.
So let's look at a couple of 10-baggers to see how they did it.
First Example: Amazon
Amazon (AMZN -0.27%) stock zoomed about 1,000% in its first year and a half as a public company. Even though it was posting net losses and negative cash flow at that time, its sales increased almost 650% during that time.
The financial results aren't too surprising. Young growth companies rarely report positive earnings. They're in high-growth mode, which by default requires heavy spending that weighs down the bottom line. There are definitely cases of profitable growth stocks, but that's not typical.
Investors were taken with Amazon's potential, and they understood the investments needed to harness that potential and become the e-commerce leader it is today. It was a time of rapid expansion, not only in increasing sales, but in acquiring other businesses to realize its opportunities. It was still a risk, but many investors were willing to take that risk because the growth story was so clear.
Data source: YCharts
Over the past 25 years, sales growth has significantly outpaced Amazon's stock gains, although the share price increase still goes down as one of the best in stock market history.
Second example: Netflix
Netflix (NFLX 1.49%) offers lessons similar to Amazon. In its early days, it reported profits even as it was cash-flow-negative. That was due to its ability to amortize content expenditures, only recording a portion of the costs as expenditures on its income statement.
But the stock soared right along with revenue (until last year, when a loss of subscriber disappointed investors) gaining more than 2,000% in the prior 10 years while sales rose more than 1,000%.
That doesn't mean every company in this situation will become a 10-bagger, or that each one is a worthwhile investment. But a company that consistently demonstrates the ability to increase revenue over time is showing investors a few things. One, it has a product that customers need or want. Two, it knows how to engage its market. Three, it knows how to sell its product. These create the foundation of a business that can succeed.
There's more than one factor to identifying great stocks to invest in
Investors should carefully evaluate every stock they consider purchasing from different angles. If you're looking for the next 10-bagger, high sales growth is the place to start. Once you've identified that, you can go on to checking how well it's using its funds and generating cash. Then you can determine whether you think the business has long-term viability.
And keep in mind that investing is not a race or a contest; solid businesses will likely gain over time, and your goal is to see your money grow.
John Mackey, former CEO of Whole Foods Market, an Amazon subsidiary, is a member of The Motley Fool's board of directors. Jennifer Saibil has no position in any of the stocks mentioned. The Motley Fool has positions in and recommends Amazon.com and Netflix. The Motley Fool has a disclosure policy.
