How To Spot The Next Eight-Bagger

Published in Company Comment on 12 June 2012

How do you spot a growth star before it's too late?

It's easy to be wise with hindsight, but the really successful investors are the ones that can spot a growth trend before it takes off.

Investors who turned down the chance to invest in Oxford Instruments (LSE: OXIG) in 2009-10 will certainly be asking themselves what they missed. Shares in the high-tech Oxford University spin-off have risen by 750% in the last three years, and the company has just unveiled another record set of results.

Beating expectations

Oxford Instruments' revenues rose by 28.6% to £337.3m over the year to 31 March 2012, with adjusted profit before tax up 60.3% to £42m and orders up 23.5% to £337.8m. These results beat analysts' expectations on all counts, suggesting another year of strong growth is on the way.

It wasn't always like this; until 2010, Oxford Instruments' share price had spent a decade doing nothing much. If you'd held Oxford Instruments' shares from June 1999 to June 2010, you'd have been up a modest 30%, plus some pretty average dividends.

What happened?

Oxford Instruments makes a range of high-tech tools and systems for use in industry and research. It specialises in two main areas: nanotechnology and industrial products, which includes superconducting technology.

Like most companies, it suffered during the 2008-9 recession but used the opportunity to restructure and position itself for a recovery. I believe its success is mostly due to a combination of its well-timed restructuring efforts and the underlying strength resulting from two decades of developing and producing high-technology products for specialist applications.

Oxford's success didn't come out of nowhere -- a lot of hard work took place beforehand, something that a canny investor can often recognise. This kind of in-depth research is something that the Fool's team of analysts spends a lot of time on -- and you can find out some of their latest share tips in this recent report, "Top Sectors For 2012". I recommend it.

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Spotting the next one

Oxford Instruments' share price has risen by 750% over the last three years. It now sits on a price-to-earnings ratio of 19.6 with a valuation of 5.4 times its book value and a dividend yield of just 0.9%.

To me, this suggests that a gradual slowdown of growth is likely over the next couple of years, hopefully accompanied by an increase in dividend yield to provide investors with a reason to hold.

Anyone seeking further growth might still consider Oxford Instruments, but would probably prefer a company at an earlier stage of the growth curve. So how you do you identify a growth star in the making?

Star characteristics

I took a look at the fastest-growing companies from the last three years in the FTSE 100 (UKX), FTSE 250 and FTSE Small Cap indices:

Company3-year growthSector
FTSE 100  
ARM Holdings (LSE: ARM)359%Technology Hardware & Equipment
Croda International (LSE: CRDA)323%Chemicals
FTSE 250  
Oxford Instruments756%Electronic & Electrical Equipment
Elementis (LSE: ELM)672%Chemicals
Imagination Technologies Group (LSE: IMG)446%Technology Hardware & Equipment
Senior (LSE: SNR)445%Aerospace & Defence
FTSE Small Cap  
Dialight (LSE: DIA)765%Electronic & Electrical Equipment
XP Power Ltd (LSE: XPP)458%Electronic & Electrical Equipment
TT Electronics (LSE: TTG)443%Electronic & Electrical Equipment

These companies all have a surprising amount in common, highlighting star characteristics that should appeal to growth investors:

  • High-end industrial sector -- high tech, specialist chemicals or engineering.
  • Strong intellectual property portfolio -- in the case of ARM and IMG, generating IP and licensing or selling is its business.
  • Cutting edge products with practical, scalable applications -- nothing too exotic.
  • Few direct competitors.
  • Strong R&D expenditure.

Companies with the above attributes benefit from a number of advantages that help them defend and grow their market positions.

Their businesses have a relatively high barrier to entry and their customers appreciate their offerings, which are often unique. For example, Oxford Instruments' superconductor products use a lot of copper, but the company is protected from volatility in the price of copper because it passes all copper price changes directly onto its customers.

The important point here is that the customers aren't paying for copper; they are paying for Oxford Instruments' unique tools, products and intellectual property.

Good luck

I reckon the best place to start looking for early-stage growth companies is in the middle and upper reaches of the FTSE Small Cap index. These companies have some scale and maturity but still have plenty of room to grow. However, that's just my opinion -- why not leave a comment below and let me know what you think -- and remember to check out "Top Sectors of 2012".

"10 Steps To Making A Million In The Market" is the very latest Motley Fool guide to help Britain invest. Better. We urge you to read the free report today -- it may transform your wealth.

Further investment opportunities:

> Roland does not own any of the shares mentioned in this article.

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Comments

The opinions expressed here are those of the individual writers and are not representative of The Motley Fool. If you spot any comments that are unsuitable hit the flag to alert our moderators.

Cisk999 12 Jun 2012 , 12:49pm

Hi Roland, for similar areas you could also take a look at Carclo (done well over the past 3 years), or if medical instruments / diagnostics are your bag, maybe EKF Diagnostics / Avacta / Deltex?

The issue with some of the stocks in the article is that they have had amazing runs over the past few years - far better to catch a sleeper before it turns into a star (or not - as the case may be...) than to buy a company that has already appreciated many times over.

I'm personally keen on the medical diagnostic industry - a relatively-recession proof sector with substantial growth potential.

DANordic 12 Jun 2012 , 1:12pm

Cisk999 - Medical diagnostic tips? :-D

sopavest 12 Jun 2012 , 1:25pm

@Cisk999

Thanks for your comment. The companies in the article were intended to be examples of growth stocks that have done the business and might provide clues as to the what investors should look for when trying to identify companies like this before they start growing.

I agree that most of them have probably done the majority of their growing already.

Medical diagnostics sounds like an interesting area where some of the same characteristics will be on display -- valuable intellectual property, high tech/niche technology and the potential for growth at decent margins.

Good luck with that!

Cheers,

Roland (article author)

Cisk999 12 Jun 2012 , 5:43pm

Roland, DANordic - of course I'm not qualified to give tips on the Board ;-)

It's just an area of interest to me and one that seems to be attracting a bit of M&A activity with the recent takeover of Axis-Shield by Alere.

Also one is always on the hunt for sectors that are growing but also less likely to be hit by recessionary woes...

bouleversee 13 Jun 2012 , 4:58pm

I have held Oxford Inst. for many years and at one point was losing money. Good that they have shot up recently but with such an increase in profits why are they so mean with the dividends? EPS doesn't pay the pensioner's ever increasing bills and unless one sells, it is only a paper profit.

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