COMMENT
Tomorrow's Growth Share Winners

By Maynard Paton (TMFMayn)
September 7, 2005

All private investors dream of finding the next GlaxoSmithKline (LSE: GSK). In 1965, the company was worth £64m, had started to dabble in the then fledgling pharmaceutical industry and was sixteen years away from hitting the big time with ulcer treatment Zantac. These days, Glaxo is worth £79b -- up a stunning 123,000% in 40 years -- a gain that excludes some mighty dividends collected in the meantime!

Dynamic growth shares such as a 1965 Glaxo will I hope form a major part of Champion Shares -- the exciting, brand new investment service from The Motley Fool. Here's my quick five-point guide to finding some of the great winners of tomorrow:

1. Growing industry or revolutionising an existing sector: A dynamic growth company must have long-term expansion opportunities. Glaxo was there at the dawn of the emerging pharmaceutical industry. Tesco (LSE: TSCO), on the other hand, was already selling food when it saw the advantages of larger, out-of-town locations. It then helped lead a revolution away from the traditional corner shop and has since lead another revolution selling non-food goods! Tesco, for what it's worth, has seen its market value improve 75,400% since 1965!

I reckon specialists involved in, for instance, the Internet, 3G, microchips, software or healthcare, or a firm 'shaking the rules' in conventional areas such as retail, finance or transport, could make for a great Champion Shares 'fast grower'. In fact, I'm increasingly finding new issues as a fertile hunting ground for growth. Plenty of smaller companies are now joining the market and offering what I consider to be ground-floor opportunities in promising, innovative sectors.

2. Rapid and organic sales growth: I'm not too interested in a blue-sky gamble. Instead, I want companies that have already demonstrated their potential. Rapid top-line progress is by far the best evidence for me, especially if it's organic and based on deals with respected customers. Admittedly, I can live with a 'fast grower' not earning a profit. In my experience, superior sales growth can eliminate losses in time -- but I've got to be sure breakeven comes sooner rather than later!

3. Market leader: This is important. The worst growth share to hold is an over-rated Johnny-come-lately that lacks the resources to sustain its progress. I want a sector 'first mover' and/or front runner. If the company is profitable, I'll look for high operating margins for evidence of a competitive advantage. Whatever, I'll certainly study the company for protective 'barriers' -- such as patents, branding or customer switching costs -- that can keep rivals at bay.

I also believe a key element to any fast-growing firm is management. I want to see the founder -- with all his or her entrepreneurial and creative talent -- at the helm and turning their growth-share ambition into reality. Certainly among smaller growth companies, running with 'founder management' is all important to me.

4. Net cash and cash generation: Fast growers are always prone to hitting speed bumps. If trouble does strike, I want the company to recover smartly. A substantial net cash pile, I feel, is one of the most reliable ways of surviving any difficulties. That said, I really prefer to spot trouble at a business before it occurs!

Something few growth investors ever check is cash flow. I've witnessed numerous fast-expanding companies haemorrhage cash, which to me suggested their rapid sales/earnings growth was nothing more than an accounting illusion. Indeed, here are five growth share impostors I spotted before they crashed and burned following terrible cash management.

5. Cheap valuation: Essentially I want to buy growth at a reasonable price. But judging how much to pay for a company expanding at, say, 20% a year, is tricky. Depending on how long the growth rate lasts, 30, 40, or even 50 times earnings, could be justified. In fact, you could have bought go-go Google (Nasdaq: GOOG) last year at almost 60 times earnings... yet tripled your money within twelve months! To a certain extent, there'll be no hard and fast valuations rules for my Champion Shares fast growers. But I'll do some rough projections and ensure the shares have room to produce a 100% gain within three to five years.

What now?

So which shares am I investigating as possible Champion Shares fast growers? Unfortunately, the growth opportunities I'm actively monitoring can't be revealed here. But what I can say is that there is no shortage of possibilities. A quick trawl on a popular share-filter website listed over 400 quoted companies that had doubled their top line within the last five years!

The companies I'm watching will be eventually revealed when the Champion Shares service launches in the near future -- though I can't promise any will produce anything like Glaxo's 123,000% return! To learn more about Champion Shares and the opportunities it will recommend, just pop your e-mail address in the box below.

Maynard owns shares in GlaxoSmithKline. Sadly, he bought them a long time after 1965 but hopes also to find the next Glaxo soon!