The best stocks in the market have produced life-changing wealth for their investors. Take the strongest companies with the brightest prospects and hold them for the long run, and you can see your money multiply by 10, 25, or even 100 times.
I can't promise I know what today's monster-stocks in the making are. But there are certain qualities we can look for -- qualities that give you the potential for huge gains in 2018 and beyond.
Chart showing growth with 2018 written on it
Image source: Getty Images
Below, I'll describe why five stocks -- all with valuations near or below $10 billion -- could prove to be monster investments in 2018 and beyond. If you have the stomach for volatility and the patience to hold for the long term, Paycom (NYSE: PAYC), Ellie Mae (NYSE: ELLI), Axon Enterprises (NASDAQ: AAXN), Shopify (NYSE: SHOP), and Bitauto (NYSE: BITA) could be right for you.
Taking the barbell approach
This might sound a bit arcane, but the "barbell approach" is a simple idea that comes from the teachings of trader/philosopher Nassim Taleb. Simply put, most of a company's resources should be devoted to a solid business that has a wide moat protecting it.
But instead of resting on its laurels, the company should also devote a small portion of its budget to high risk/high reward ventures, creating small losses but the potential for big gains.
First, let's tackle the wide moats. Each company's primary advantage is described below.
Company
Moat
Explanation
Paycom Solutions
High Switching Costs
Companies use Paycom's cloud software to handle payroll and human resource processes. Revenue retention rate last year was 91%.
Ellie Mae
High Switching Costs
Network Effect
Mortgage industry uses the Encompass platform for all steps in mortgage process.
Because companies can get leads from being part of the platform, each additional user adds significant value.
Axon Enterprises
Brand
High Switching Costs
Axon's TASER's have dominant market-share thanks to its brand.
Police departments would have very high switching costs migrating body camera footage away from Evidence.com
Shopify
High Switching Costs
Network Effect
Companies would be loath to migrate their e-commerce operations away from Shopify.
With 500,000 merchants, app developers flock to Shopify, which draws in more merchants.
Bitauto
Network Effect
Yixin Capital is connecting auto financers, banks, and insurance companies
Data source: SEC filings
The other side of the "barbell" relies on finding proof that a company is multi-dimensional -- that it can pivot from one type of business to another if the opportunity arises. If we use Netflix as our example, the pivot from DVD to streaming would be evidence of its high-reward venture.
Paycom, Ellie Mae and Shopify have all demonstrated their ability to evolve by offering increasingly diverse tools for their customers to use.
Paycom has gone well beyond payroll to encompass a huge swath of human resources applications.
Shopify's start was as a subscription-based plan to set up merchants' e-commerce presence, but has since expanded to include Merchant Solutions -- which helps with logistics.
Ellie Mae's demonstration of its flexibility -- admittedly the weakest of the bunch -- comes from the company's acquisitions, which make the entire mortgage process as seamless as possible.
Axon made the biggest pivot of the bunch, maintaining its focus on non-lethal weapons while expanding its Axon line of body cameras. It is also adding lots of new tools to the Evidence.com platform through its AI initiative.
And Bitauto originally got its start by helping to design virtual show rooms for Chinese auto dealers, and selling ad space on those sites. It was the transition to transaction services -- via Yixin -- that the company demonstrated its ability to adapt when opportunities arise.
Financial fortitude to stay afloat
Every company will face difficult economic times.
Cartoon castle with coins on it
Image source: Getty Images
Having cash on hand -- and not too much debt -- is key. It keeps the company afloat when trouble hits. While some of these companies are still waiting on strong free cash flows to start, they all have healthy balance sheets.
Company
Cash
Debt
Free Cash Flow
Paycom
$201 million
$33 million
$62 million
Ellie Mae
$479 million
$0
$0
Axon
$61 million
$0
($21 million)
Shopify
$927 million
$0
($22 million)
Bitauto
$7.6 billion yuan
$5.6 billion yuan
N/A
Data sources: Yahoo! Finance, SEC filings. Cash includes long and short-term investments. Free cash flow presented on trailing 12 month basis. N/A = Not available.
It's important to note that much of Axon's free-cash-flow bleed is due to concurrent build out of the Evidence.com platform and an offer for free Axon cameras and one-year subscription to Evidence.com.
As a Chinese listed company, it can be more difficult to get granular numbers on cash flow from Bitauto, which should be taken into consideration as a risk for investors. The company's decision to spin out Yixin on the Hong Kong exchange, while maintaining a controlling interest in the company, is also important to note moving forward.
Skin in the game
Finally, I like it when my investing dollars are aligned with management's. Having a founder who leads a company and views it as an existential extension of him/herself only adds to that conviction.
Additionally, I like it when employees have their skin in the game too. I measure that by seeing the reviews that employees give the company via Glassdoor.com. Five stars is the highest rating, with anything at or above 3.7 being considered positive, in my book. Here's how they stack up.
Company
Founder's Role
Insider Holdings
Glassdoor Reviews
Paycom
CEO and Chairman
17.9% of voting rights
4.2 stars
Ellie Mae
Chairman
3.4% of voting rights
4.5 stars
Axon
CEO
2.8% of voting rights
4.2 stars
Shopify
CEO and Chairman
59.7% of voting rights
4.3 stars
Bitauto
CEO and Chairman
13.4% of voting rights
N/A
Data source: Company websites, Glassdoor.com, SEC filings. Insider holdings accurate as of most recent proxy DEF 14A filing. N/A = Not applicable due to only one review of Bitauto on Glassdoor.com
There's no way to know if any of these stocks will produce monster returns. But they don't have to in order for you to prosper as an investor in 2018 and beyond. By holding shares of all five of these companies in the new year, you expose your portfolio to a powerful combination of factors.
And lest you think these are empty words, my money is firmly where my mouth is: 13% of my personal holdings are invested in these five companies combined. I think they are all worthy of your consideration in 2018 and beyond.
Brian Stoffel owns shares of Axon Enterprise, Bitauto Holdings, Ellie Mae, Paycom Software, and Shopify. The Motley Fool owns shares of and recommends Axon Enterprise, Ellie Mae, Paycom Software, and Shopify. The Motley Fool has a disclosure policy.
