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It's mid-December 1999. The stock market is rockin', and you're kicking back at the bar after work with your pals, throwing around ideas for stocks that will lead Wall Street over the next six years.
On your list are probably the usual Internet heroes, like eBay (EBAY, news, msgs), and maybe a biotech, like MedImmune (MEDI, news, msgs) or a fast-growing store, like Starbucks (SBUX, news, msgs).
But boy, oh boy, would you have been wrong. The leading stock over the past six years, according to my calculations, makes just about the least exotic product you can imagine: soda pop. It's Hansen Natural (HANS, news, msgs), which is up 3,739% since Jan. 1, 2000. And the next four best aren't exactly household names, either. They are:
The incredible success of these unassuming businesses provides investors with valuable insights into the character of our age and what makes stocks go up.
It's obviously not glamorous CEOs, hyped-up investor-relations campaigns or sexy products, although none of those things will actually hurt. It's mainly about finding an underappreciated niche that's small enough to be ignored by much larger players -- and then developing a pipeline of products that can be sold for many years at relatively high margins to an increasing number of customers. All of these market-leading companies crush their peers on returns on capital and pricing power: business fundamentals that allow them to continually grow into valuations that seem perpetually cheap.
Still cheap after the run-up
Did I say cheap? That's right. Even though these five super outfits have walloped the market in the past six years -- the S&P 500 ($INX) is down 12% during that stretch, while the Nasdaq ($COMPX) is down 35% -- they are still relatively inexpensive because they continue to boost earnings faster than analysts can update their estimates.Consider KCS Energy. The natural gas driller and developer is expected to earn $3.24 per share in 2006, up 47% from 2005. Yet its forward price-earnings multiple is just 8.4, which is about six times lower than it would be if investors really believed that kind of growth will materialize as expected.
Or how about Hansen Natural? It is expected to earn $2.97 per share in 2006, or 30% more than in 2005. And yet its price-earnings multiple on that estimate is just 27. To give you an idea of how out of whack that is, consider that Coca-Cola (KO, news, msgs) is expected to grow 7% next year, yet its price-earnings multiple is more than double its growth rate, at 18. If Coca-Cola were valued like Hansen, in other words, it would be at around $21.50 instead of $43.
Beating low expectations
The market continues to underestimate these smaller companies in part because investors tend to disbelieve high-growth stories in non-glamorous industries. When expectations are relatively low, exceptional companies can easily beat them. And it's that disconnect between expectation and reality that drives prices higher. As the expectational gap slowly closes, more and more investors decide to take large positions in the stock. And as they grow more and more comfortable with the story, they give the company higher price-earnings multiples.Rate this Article
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