3 (Risky) Tricks for Finding Monster Growth Stocks
Stocks with big upside potential often have significant risks, too.
Monster growth stocks have the power to keep outperforming the market year after year, and that's why practically everyone loves to have them in their portfolios. But those stocks wouldn't be notable enough to have a nickname if they were common or easy to find.
Thankfully, there are a few quick guidelines you can use to increase your chances of finding promising monster stocks in the making. The catch is that you need to use these tricks responsibly rather than blindly, as they tend to leave you exposed to certain inherent risks. Let's dive in and explore what that means so you'll get the hang of how to hunt potential monster growth stocks intelligently.
- Avoid searching for monsters in mature industries
The first trick to finding tremendous growth stocks is to look in the places you're most likely to find them: immature industries. In immature industries, there's a lot of diversity and experimentation with product design, business models, product-market fits, and investor narratives. In contrast, mature industries feature overall profitability, the presence of oligopolies, and businesses returning capital to shareholders rather than investing for growth.
The cannabis industry and the psychedelics segment of the biotechnology industry are still years away from becoming mature, and they're both chock-full candidates for strong growth. However, with immaturity comes risk. Businesses like Tilray Brands (TLRY -4.70%) in cannabis and Atai Life Sciences (ATAI 1.70%) in psychedelics are among the leaders of their markets. Still, neither is profitable nor has any clear competitive advantages that might lay the foundation for dominance in the future. Both business models are unproven, making them somewhat odd compared to their peers. For example, it's unclear whether Tilray's gambit to brew and distribute beer in the U.S. will be an asset or a liability for its shareholders in the long term, especially given that the company started as a marijuana cultivator before becoming a somewhat diversified business. Likewise, Atai's model features a portfolio of semi-independent small biotech companies, and it could one day become a blueprint for success in how to do drug development within psychedelics -- assuming it doesn't devolve into a disorganized tangle of overlapping and cash-burning efforts.
Still, taking those strategic chances, both stocks have potentially high growth ahead but are also potential flops. The bottom line is it's much easier to find such opportunities in industries that aren't crowded with mature competitors. 2. Look for early-stage or unprofitable businesses with aggressive plans
In keeping with the prior point, young businesses are far more likely to grow a considerable amount than older ones, especially if their addressable market is expanding simultaneously. Focusing on finding smaller, unprofitable players in such industries is generally a good start. But merely buying shares of those stocks is too risky of a strategy on its own; as the old saying goes, anyone can sell $1 for $0.75.
One telltale feature of future monsters is that they have ambitious plans for growth that will generate value for shareholders even before the plans are complete. Take SNDL (SNDL 0.24%), for example. As with Tilray, its marijuana cultivation operations are unprofitable. But its liquor distribution operations, which it initiated as part of its plan to become one of Canada's leading competitors in regulated markets, are profitable and generating cash. In other words, the stepping stone it took by acquiring a major liquor distributor immediately added value, and it'll likely continue to do so while management puts together the other pieces of the plan. And that gives a candidate for becoming a monster a bit more staying power before it (potentially) starts to boom with growth.
Just remember that aiming for the stars doesn't guarantee that a company will be successful. Many unprofitable businesses with big plans never become profitable. 3. Prefer cash-rich companies that are keen to write checks for acquisitions
One way for a monster to grow big and strong is to have a lot of cash to spend on food, which in this case means buying smaller businesses to procure their market share, cash flow, technology, or human capital.
As an example, at its peak, SNDL had more than $714 million in cash after issuing a bunch of shares during the meme stock mania of early 2021. Since then, it has purchased a slew of Canadian cannabis companies, not to mention the biggest Canadian liquor distributor. In the past three years, its trailing 12-month (TTM) sales exploded by more than 700% as a result. And with its $213.1 million remaining, you can bet that other acquisitions will be in the works. That might well make for astonishing growth.
Nonetheless, the risk of investing in a small company with a big wad of cash is that management will get ahead of themselves and make acquisitions that destroy value instead of creating it. While sometimes it's smart to diversify by tacking on a newly purchased business unit that competes in a new area, it's also prevalent to see (in the words of the illustrious investor Peter Lynch) "diworsification" by diving into markets where the company has no competitive advantage and no way of gaining one. Moreover, acquiring unprofitable competitors means burning money even faster until things change, something that has felled many an aspiring monster stock.
Alex Carchidi has no position in any of the stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. The Motley Fool has a disclosure policy.