What Kind of Easter Egg Hunt Are You In?
Dear Leah, In the spring of 2000, a man named Reed Hastings traveled to Dallas with a big business idea. Hastings approached the management of movie rental giant Blockbuster with a proposal. He wanted Blockbuster to buy his small business for $50 million. At the time, Hastings’ company – called Netflix – had a promising business model. It allowed people to rent movies through the mail. Netflix was also small and struggling to turn a profit. Hastings believed a Blockbuster purchase of Netflix would be a win-win deal for both parties. Blockbuster’s managers did not. They didn’t think Netflix’s business model made sense for them. A Netflix executive later said that Blockbuster essentially laughed Hastings out of the room. You probably know the rest of the story. Netflix secured investment from other sources and built a hugely popular mail-order DVD rental business. Around 2007, it made a brilliant move and began transitioning into America’s No. 1 movie and television streaming service. This innovation crushed traditional brick-and-mortar rental companies like Blockbuster. In 2002, Netflix had less than 3 million subscribers. By 2022, it had reached 222 million subscribers and climbed to a market valuation of $129 billion. Blockbuster’s market valuation in 2018? Zip. It went bankrupt a long time ago… and its “pass” on Netflix is widely regarded as one of the worst decisions in modern corporate history. To give you an idea of how an investor would have done with an early Netflix stake, consider that Netflix stock fell to a split-adjusted low of $0.35 per share in 2002. Assume you did not buy the bottom, but instead invested $5,000 at $0.50 per share, picking up 10,000 shares of Netflix. In 2022, that $5,000 investment would have been worth $2.87 million… a 574-fold return. Netflix’s story is one of my favorite examples of one of the most powerful concepts in the world of finance and investing. The concept? If you want to make giant returns in stocks, you must be in the right Easter egg hunt. Below, I explain why… How to Find Stocks That Can Return 100-Fold Hide On Wall Street, companies are often grouped and labeled according to their size. Investors typically place a company in one of three size categories: large-caps, mid-caps, and small-caps. “Cap” is short for “market capitalization.” This is the term used to describe the value of a public company. To figure out a company’s market cap, all you have to do is multiply the total number of shares the company has in the market times the market price of a single share. The group names are common sense. Large-caps are large. Small-caps are small. Mid-caps are in between. For example, the popular software company Microsoft is a large-cap. In November 2022, its market cap was around $1.79 trillion. Or, take iPhone maker Apple. It’s also a large-cap. In November 2022, its market cap was around $2.4 trillion . Mid-caps are smaller than large-caps. Typically, investors consider companies with market caps in between $2 billion and $10 billion to be mid-caps. The difference between a large-cap and a mid-cap can be huge. A mid-cap company worth $5 billion is less than 0.2% of the size of giant Microsoft. Finally, we have small-caps. These are companies with market caps under $2 billion. While the difference between a mid-cap and a large-cap can be huge, the difference between a small-cap and a large-cap can be incredible. For example, take a small-cap with a market value of $500 million. This is just 10% of a mid-cap with a market value of $5 billon… which means it is less than one tenth of one percent the size of a large-cap like Microsoft. Large-caps can be good investments. They are typically stable, established, profitable companies. They often pay dividends. Large-caps can be great investments for conservative investors. But if you’re interested in making 10, 20, or even 50 times your money (or 574 times your money like with Netflix) in a single investment, you’d be smart to look at small-cap stocks. Small-cap companies have much greater potential to produce giant returns for their shareholders in a short time than any other kind of company. The reason is simple… It’s much, much easier for a young, $500 million small-cap to grow 10-fold than it is for a mature $500-billion giant to grow 10-fold. That’s just basic math. If your daughter sold 10 boxes of Girl Scout Cookies around the neighborhood on her own, you could probably help grow her results 10-times (selling 100 boxes) by driving her around, putting a little pressure on your friends, neighbors, and coworkers to buy some boxes. But what if your daughter was a natural saleswoman and had sold 100 boxes on her own? To enjoy 10-times growth under that scenario, she’d have to sell 1,000 boxes. Not so easy anymore. That’s the mathematical challenge behind enjoying giant growth when a company is already doing giant sales. Or, think about these situations… - When a small $300 million market-cap beverage company creates a hit product that generates an additional $1 billion in sales, it’s a huge deal that can make the company’s stock rise by hundreds or thousands of percent.
However, if beverage giant Coca-Cola creates a way to generate an additional $1 billion in sales, it barely registers on its massive income statement. - When a small $200 million restaurant company with 40 locations expands to 200 more locations, its market value can soar. But if mega-chain Starbucks adds 200 new locations to its already massive 14,000+ locations, it’s a blip on the company’s balance sheet.
- When a small $600 million software company creates an amazing new way to collect, manage, and analyze healthcare data, financial data, or marketing data, it can increase revenue by over $1 billion… and its stock can soar 10-fold.
However, if giant Microsoft adds $1 billion to its $100 billion+ annual revenue, it’s a drop in the bucket that won’t even make the news. Now, all this DOES NOT mean a large company is automatically a bad investment. It just means that it’s not an ideal investment for someone looking to make big returns in a relatively short period of time. Remember, a $500 million small-cap is just one-tenth of one percent of a $500 billion large-cap. That’s why a search for stocks with huge growth potential should start in the small-cap stock world. This is where companies with the potential to grow 10, 20, 50… even 574 times larger live and hide out. But it gets even better for small-cap investors. There’s another tremendous benefit they enjoy that large-cap investors do not. I believe this benefit is best explained with the story of an Easter egg hunt, which I will explain in the second part of this series. Stay tuned for that in tomorrow’s Market 360. Regards, | .png)
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