Finding the Next 5,000 Percent Gainer

Financial publications are fond of writing about the fabulous gains in great companies if you'd only gotten in early. Examples of stocks that would make you a millionaire if you bought early and just held on include Walmart, Microsoft, Home Depot to name just a few.

Microsoft provides a good case study. Microsoft peaked at $58 and change right at the end of 1999. Then came the collapse of the tech bubble. Microsoft has done nothing but go sideways for seven years. Finally on Friday Microsoft hit a six year high of $35 after reporting a superb quarter that showed all lines of business were executing exceptionally well.

Microsoft IPO'd about 1985. On a split adjusted basis a share of stock was worth 9.5 cents. From that point to the peak is a return of 6,110%. Many times people look at a stock that has moved strongly from the lower right to the upper left and feel that they've "missed the boat". If you'd bought Microsoft at the beginning of 1990 a share would have cost about $0.64. The stock would already have gone up 670%. But you would still have made a 910% return at the peak. If you bought Microsoft in 1995 a share would have cost $3.71 on a split adjusted basis. Over the next 5 years you would have a return of almost 160%, or an annualized return of 32% a year.

Somewhere today there is the next 5,000% stock. While hindsight is entertaining it is not particularly profitable. What are the characteristics of a stock that can return 5,000% over 15 or 20 years?

In the case of Microsoft it was a defensible franchise in a fast growing industry, personal computers. Microsoft's operating system dominance meant that they grew as the industry grew. Many additional products put out by Microsoft over the years, such as Microsoft Office and Internet Explorer, have been successful and profitable in their own right, but essentially were developed to protect the core operating system franchise.

I own a lot of different stocks and I own them for a lot of different reasons. But of all the stocks I own the one that I think may turn in a Microsoft performance over the next 10 years is Google. Google IPO'd 3 years ago for $85 a share. I first bought Google in late 2006 for $410. At that time Google had already posted a return of 482%. Friday, Google's closing price was $674.60, representing an increase of 794% since the IPO.

Google has not split its shares and the high stock price along with concerns over the sustainability of its growth have meant that the shares have climbed a "wall of worry" and moved up in a rational way based on its continued strong earnings. The stock remained fairly flat last year and early this year. But with the latest quarter analysts are starting to become more comfortable that growth and earnings are not going to slow down precipitously - at least not in the foreseeable future.

Like Microsoft, Google has a dominate position and a defensible franchise in an industry that is expect to grow for a long time - search and Internet advertising. Google's search algorithms continue to improve and this latest quarter showed financial gains based on more accurately targeted advertising based on search results.

Like Microsoft, Google's business model generates huge amounts of free cash flow. This gives Google the ability to invest in widening its moat and invest in other products and services for future growth. Google has its fingers in a lot of pies, but they have been disciplined in that most of these initiatives are either meant to defend the core franchise (like Microsoft realizing that it had to win the Internet browser war), or meant to expand its footprint within the scope of it's stated mission. That mission is to organize the world's information and monetize the access of that information. There has been no move by Google that just doesn't fit, like Ebay's acquisition of Skype (which Ebay just took a massive write-down on).

Google is a global growth story with about 50% of its revenue coming from outside the United States. Google continues to gain market share in almost every market in which they compete. They are even gaining market share in the U.K. where their market share is already 70%.

It is much harder to see the future than to review the past. But I believe Google has a good chance of being a 5,000% gainer. Check with me in 10 years and we'll see how it turned out.

Disclosure: at the time of this posting the author was long MSFT and GOOG.