Big Stock Ideas for Big Profit

Big ideas for big profit
The biggest ideas and the biggest resulting profits, almost without exception, belong to entrepreneurs.

Guys like Microsoft's (Nasdaq: MSFT) Bill Gates and Apple's (Nasdaq: AAPL) Steve Jobs, who wanted to make computers accessible to the common man. Or someone like Steve Wynn, who is behind some of the most famous names on the Las Vegas Strip: Bellagio and The Mirage (both now owned by MGM Mirage) and Wynn and Encore (owned by his company Wynn (NYSE: WYNN)).

The problem is that entrepreneurs also take the biggest risks. For every Gates, Jobs, and Wynn, there are hundreds of flameouts. The thousands of hours of work dedicated to one idea come to nothing.

A better way
One group found a way to circumvent the system a little. They're called venture capitalists (VCs). Instead of taking a big risk on one idea, VCs provide funding for a portfolio of ideas. By investing in multiple boom-or-bust companies, they mitigate their risk somewhat.

There are still many flameouts, but the investments that hit, hit big. So big that the savvy venture capitalists' winners more than make up for their losers -- earning above-market returns in the process. To give you a feel for the returns possible, the market's historically returned 8%-10% average annual returns; venture capitalists generally target 20%.

How we can profit
Perhaps because he's an entrepreneur, Motley Fool co-founder David Gardner loves the venture-capitalist mentality. In fact, it's his approach to investing in individual stocks -- he seeks out a portfolio of companies that have the potential to be the ultimate growth stock stories of tomorrow -- the next Microsofts, Apples, and Wynns.

Since there are inevitably plenty of losers to go along with the winners, though, this investing approach is tricky business. Even for those investors who can stomach it, David only recommends allocating a minority of your portfolio to this type of investing -- "anywhere from 5% to 30%, depending on time horizon and risk tolerance."

Identifying the winners
For those who want to hone their ability to separate tomorrow's runaway winners from tomorrow's bankruptcies, David has identified six signs of the next big disruptive growth stock:

1. Top dog and first-mover in an important, emerging industry
2. Sustainable advantage gained through business momentum, patent protection, visionary leadership, or inept competitors
3. Strong past price appreciation
4. Good management and smart backing
5. Strong consumer appeal
6. Proof that it is overvalued according to the financial media

Looking at this list, you may see one of the difficulties of these types of stocks. They're rarely cheap by traditional valuation metrics like P/E ratios.

In fact, No. 3 and No. 6 show that David actually prefers when there's evidence of overvaluation. It's counterintuitive (especially to value hounds like me who usually go for low-P/E plays), but truly disruptive growth stocks tend to stay expensive as their earnings growth continues to support the high trailing multiples.

David enjoys the cries of overvaluation from the financial media because it keeps some investors away -- the same investors who will eventually capitulate and pile in at higher prices.

Some true disrupters
The danger is paying too much for a stock that's not a true disrupter. If the future growth story isn't there, it's just a loss waiting to happen.

To help you implement David Gardner's six points for spotting a true disrupter, here are three companies he's recommended, along with the status quo they are trying to disrupt:

Disrupter	Status Quo	What They Do
Intuitive Surgical (Nasdaq: ISRG)	Traditional surgery	Robotic surgery
Under Armour (NYSE: UA)	Nike (NYSE: NKE)	Athletic apparel
VMWare (NYSE: VMW)	Microsoft	Virtualization / Cloud computing

It's easy to see how cloud computing or the use of robots for surgery disrupts the status quo; I included Under Armour to remind you that disrupters don't necessarily have to be technology-based. Under Armour is doing it by building a brand.

There's a disconnect here, though. Microsoft, which I pointed to earlier as a prototypical disrupter, is now part of the status quo, fighting the advances of VMWare and others. This is the life cycle of a growth company ... at some point a successful disrupter blows apart the ecosystem so thoroughly that it becomes the entrenched Big Dog.

Thus, most investors correctly view Microsoft as a mature blue chip whose heady growth days are behind it.

Meanwhile, the other examples I cited -- Wynn and Apple -- are still generally seen as growth opportunities. Even in the face of a recession, Wynn added its Encore additions to its Wynn properties in both Vegas and Macau within the last year and a half; Apple continues to innovate with its iPhone and iPad franchises even as it's grown to be one of the five largest companies in the U.S. (by market cap).

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