6 TRENDS TO BANK ON
The co-founder of the Motley Fool website scans his crystal ball for long-term winners.
(Fortune Magazine) – ONE OF THE VERY BEST and very worst approaches to investing is to "play the trends." At worst, home-office speculators feed capital into stocks cresting at new highs; they hope to profit by the hour. This sort of pure momentum investing is flourishing among hedge fund managers, whose one-year-bonus models lure them into very hot stocks in very sexy industries. It will not end well for their shareholders: The historical research, along with the investment philosophies of Warren Buffett and Peter Lynch, demonstrates that stock-price trends are not your friend. The most efficient way for an investor to fall headlong from prosperity into poverty is to buy shiny objects at their highest prices. But another sort of trend investing is worthy of your time and rapt attention. Patiently investing in long-term demographic trends will set up your portfolio for sustained supergrowth. You won't be rewarded for it day by day. And in its most potent form, demographics investing demands that you be profoundly contrarian. You will be buying forgotten and unforgiven stocks during painful industry downturns. But the returns can be extraordinary. We've profited from these techniques in my small-cap newsletter, Motley Fool Hidden Gems, where our picks returned 45% for the past 12 months, making it the top-performing newsletter, according to industry watcher Mark Hulbert. What follows in this article are six demographic supertrends I believe will drive select industries to sustained market outperformance over at least the next five years. In each I've identified one accompanying stock that I think will roundly beat the S&P 500. If I'm right, you will suffer this Fool gladly. If I'm wrong, and my basket of six stocks does not beat the S&P 500, I'll shave my head. Here are the six supertrends and the six superstocks I expect to squash the market.
1 HOME ENTERTAINMENT THIS PAST WINTER HOLIDAY SEASON, one out of every four gifts was a consumer electronics device, and spending in the category topped $21 billion. The industry has prospered over the past decade, in large part because you and I want to transform our living rooms into Cineplex Odeons, complete with six-foot-wide flat screens, surround sound, and the full integration of PCs, iPods, Wiis, TiVos, and DVD players. To my eye, there is no clear end in sight to this trend. Video-on-demand is just around the corner, and consumers will enjoy an embarrassment of programming riches via the Internet. Poised to benefit from each of these innovations is DOLBY LABORATORIES (DLB, $34), primarily a licensing business of superior audio technologies. After dipping 40% from the IPO price in 2005, shares have more than doubled, to around $34. A recent stock sale by founder Ray Dolby has scared off some investors—but not me. The company's balance sheet sparkles, and demand for its innovations should drive growth rates in excess of 20% per year. I think the stock will more than double over the next five years.
2 RISING OIL PRICES THE PRICE OF OIL has risen more than 60% since 2004, and I believe that consumers waiting for a permanent price drop have lost their senses. Look no farther than Asia for the explanation. By 2010, China is expected to have more than 250 million middle-class citizens, who will whiz from Shanghai to Beijing to Chengdu in automobiles (let's hope they're more fuel-efficient than the guzzlers we've been driving). Someday America will not be the largest energy consumer in the world, and on that day oil prices will be far higher. For further context, please note that, adjusted for inflation, oil prices today are actually lower than they were in 1981. Moreover, gasoline prices around the world are on average twice what they are in the U.S. As entrepreneurial capitalism continues to cover the globe, the demand for petroleum will only rise. UNIT CORP. (UNT, $62), a contract driller operating primarily in Oklahoma and Texas, is perfectly situated for sustained growth. It is one of the ten most highly ranked stocks by our Motley Fool community. Here again, I think you're looking at more than a double over the next five years.
3 EATING OUT ALTHOUGH AMERICANS are staying home for movies, we're eating out like never before. In 2007 we'll spend more than $550 billion devouring food prepared by someone else. This trend has risen steadily for the past 40 years, accelerating of late in part because more than 60% of mothers now work outside the home. The net result is a flurry of new restaurants—numbering 900,000 in America—in the categories of fine dining, fast casual, family dining, fast food, and self-service. One company that's benefiting across the board is MIDDLEBY CORP. (MIDD, $123). Its stock is down 15% from highs this year but has risen more than 20 times in value since 2000. Middleby has emerged as the leader in sales of innovative, high-quality, and energy-efficient ovens to restaurant chains. What's particularly appealing here is that the same shift in eating habits are playing out internationally, only with far more upside. And Middleby is well positioned to profit around the globe. I believe this stock also will more than double over the next five years.
4 HOMEBUILDING WITHOUT QUESTION, homebuilders are the most reviled stocks on Wall Street today. Year over year, building permits are down 28%, building starts are down 16%, and foreclosures are up 35% nationwide. The sentiment indicator of the National Association of Home Builders is at a 26-year low. Shares of one residential construction company after another have fallen at least 40%. So, you may be thinking, why the hell should I buy a homebuilder stock today?
For context, page back to 2002, and recall how Internet stocks had been dragged into the town square to be kicked and spat upon. Valuations had collapsed, weak companies were folding en masse, speculators had capitulated. At the height of that calamity I had a memorable conversation with world-class money manager Marty Whitman, founder of the Third Avenue funds. He emphasized that at the core of most bubbles is a kernel of commercial truth that will eventually expand. He cited example after example of Internet-based businesses valued at less than the cash on their balance sheet, tagged with expectations of eternally negative growth rates. Whitman counseled in 2002 that it was a wonderful time to buy those stocks, since web-usage statistics were strong. He was dead on.
I believe similar dynamics are at work in the homebuilding industry. The Census Bureau projects that by 2050 our population will have increased by 50%, to more than 420 million. We'll also be a much older society, with close to half of all citizens over the age of 45 (compared with around 37% today). What that means to me is that there will be major construction, particularly of second homes, in the Southern states. One beneficiary will be MDC HOLDINGS (MDC, $54), a homebuilder focusing on states like Arizona, Texas, and California. Accounting for dividends, MDC has rewarded shareholders with 16% annual gains over the past 20 years, which includes the 40% shellacking the stock has taken since July 2005. I expect more than a double through 2012 from MDC. (The stock is also recommended by John Eade on page 46.)
5 THE DIGITAL DOCTOR'S OFFICE TO DATE, LESS THAN 10% OF AMERICAN hospitals have implemented electronic medical record keeping as a core piece of their technology strategy for health information. The majority of primary-care physicians continue to scrawl out diagnoses and complete health-care transactions with paper and a No. 2 pencil. That's shameful. To me, there is no question that ten years from now, our health-care providers will have embraced the digital revolution (at least a decade late!). QUALITY SYSTEMS (QSII, $40) has the leading software package for electronic medical record keeping. With more than $80 million on its balance sheet, it also has the financial underpinnings to enjoy superior growth rates for years to come. This stock has already risen seven times in value over the past five years. I'm expecting more than a double over the next five.
6 ALTERNATIVE SPORTS THIS FINAL TREND makes for a great way to involve your children, grandchildren, nieces, and nephews in the joyful game of stock investing. Alternative sports in America are becoming less alternative every day, as young adults turn to more individual and outdoor sports for recreation. What's more, the number of girls participating in all forms of sport is radically higher than it was 40 years ago. That's another trend playing out across the globe. Sports like snowboarding, skiing, surfing, skateboarding, and mountaineering are gaining in popularity. One of the more compelling apparel companies on the market is benefiting from all this. VOLCOM (VLCM, $44), the purveyor of apparel and shoes for outdoor enthusiasts, came public in 2005. A year later the stock was 30% below its offering price. Since then, it has more than doubled. The financials are excellent. The business is heavily owned by executive leadership. The CEO is an authentic leader. And I am expecting in excess of 15% annual returns over the next five years.
CONCLUSION THESE SIX SUPERSTOCKS IN SUPERTRENDS will, I aver, provide superior investment returns over the next five years. I encourage all individual investors to swear off day trading based on price momentum and replace it with share owning of companies surfing major demographic trends. The sooner you do, the healthier, wealthier, and more Foolish you shall be.
Tom Gardner is CEO and co-founder of the Motley Fool (Fool.com), an investment advisory company based in Alexandria, Va. He is the author of several bestselling books, including The Motley Fool Investment Guide, and is the lead analyst for two of the Fool's most popular and successful stock-picking services, Hidden Gems and Stock Advisor.
From the June 25, 2007 issue