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Every company has its own life cycle. However, newly-formed businesses generally have the greatest potential to expand and grow -- such firms have only just begun to probe their potential market. As a result, most successful companies deliver the strongest growth in their early years of existence. But as companies expand and mature, growth tends to slow. Inevitably, as a firm expands operations, it begins to saturate its core markets. If a company is truly successful, then it will grab market share from its competitors and will ultimately become a dominant player in its industry. However, once a firm's market share reaches a certain point, it becomes extremely difficult for the company to grow faster than its overall industry. And, of course, mature companies also fall victim to the law of large numbers. For a $100 million company to deliver +20% growth, it needs to add just $20 million to its revenue base. For most firms, that's a pretty reasonable expectation. However, consider the case of a much larger firm -- a $100 billion company. If this corporate giant wants to boost its revenues by +20%, then it needs to generate an incredible $20 billion in new sales -- by no means an easy feat. Clearly, it's far easier for a small company to find the incremental sales needed to post high percentage growth rates. Of course, this phenomenon has a bearing on stock market performance. Specifically, when a company first lists on one of the major stock exchanges, it's known as an initial public offering, or IPO. When a company undertakes an IPO, it's essentially selling itself to the public in a process that generates significant capital for the firm. Oftentimes, new IPOs are relatively young companies that are looking to raise capital to fund their expansion efforts. Over the course of history, studies have shown that young firms tend to see their most dramatic revenue and earnings growth within five years of their IPO. And in the stock market, dramatic growth often breeds dramatic share price performance. A host of recent IPOs offer excellent examples. For example, Google (Nasdaq: GOOG) made its stock market debut in the summer of 2004. Since that time, the company has become the dominant player in Internet search and has launched a host of other products including e-mail and advanced ad-placement services. Google's rapid expansion has led to strong earnings and sales gains, and as a result, the stock has skyrocketed roughly +400% since its first day of trading. Of course, you can't just go out and buy every new IPO that hits the market. Market history is littered with failed IPOs -- companies that listed on an exchange but never really found a niche. For example, Pets.com -- an online retailer designed to sell pet food and supplies -- went public in the late 1990s with much fanfare. However, the company never turned a profit, and it ultimately went bankrupt within two years of its IPO. To avoid the losers, the key is to look for relatively new IPOs that are showing both strong growth and profitability. Revenue growth is desirable and characteristic of young, rapidly expanding firms. But if a company isn't turning those rapidly growing sales into actual profits, then it won't survive for long. By eliminating young companies that aren't showing a profit, we're able to weed out weak firms that have yet to prove they can carve out a legitimate market niche. And by focusing on profitability, we're not really giving up on any potential performance. Some of the best-performing IPOs of all-time are actually highly profitable companies. Google, for example, enjoys an operating margin of nearly 35%. Operating margins measure how efficiently a company converts sales into profits. With an operating margin of 35%, Google converts 35 cents out of every dollar in sales into actual operating profits. By focusing on operating rather than total profit, we eliminate the effects of extraordinary items -- such as the sale of property or equipment -- that are not related to a firm's core business. Such non-operating revenues can cloud a firm's true profitability picture. To identify tomorrow's big winners today, we need to look for companies with solid, profitable core businesses. With these points in mind, my staff and I recently hunted through our database of thousands of stocks in search of companies that met the following criteria: -- Completed an IPO after January 1, 2001 -- One-year revenue growth of +30% or higher -- Current operating margins greater than +30% -- Revenue growth over the same quarter last year of at least +30% -- Market capitalization of greater than $200 million After running these criteria through StreetAuthority's advanced screening software, we came up with the following list of companies . . .
Although each of the above stocks may be worth exploring further, as always, please make sure to do your own due diligence on each of these firms to decide if they are right for your portfolio. Any and all final investing decisions for your own account are entirely up to you. Good investing!
Paul Tracy founded StreetAuthority and became Chief Investment Strategist in 2001. Prior to that he spent several years as Managing Editor at a multi-million dollar financial publishing firm with over 150,000 subscribers. In addition to his role as managing editor and lead financial writer, he was also responsible for equity research and managing a team of seasoned professional financial writers, researchers and market commentators. Paul's previous experience includes a position at Robert W. Baird & Co.'s full-service brokerage operations as well as economic research work on a Money and Banking project funded by the National Bureau of Economic Research. He has also spent time doing outside consulting and research for the University of Virginia, has appeared as a guest expert on several prominent financial radio shows, and has been a featured speaker at various investment conferences across the U.S. Paul graduated with a B.S.
in Finance and Management from the McIntire School of Commerce at the
University of Virginia.
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