Find the 'Cream of the Crop' in Any Market With These Four Steps

Editor's note: In today's Weekend Edition, we're taking a break from our usual fare to bring you an essay from our colleague Enrique Abeyta at our corporate affiliate Empire Financial Research. In it, he walks through his key steps to identifying multibagger stocks. By remembering these four ideas, you can improve your investing success, regardless of your portfolio size...  

In my Empire Elite Growth service, my team and I are willing to wait patiently until extreme setups show up in the markets.

You don't need a huge number of holdings for an ideal portfolio – so it's critical that you make your ideas count. You want to look for the cream of the crop... unique businesses and companies in extreme situations.

To identify these companies, we look at four key criteria...

  1. Big Economic Upside

Regardless of valuation, companies that grow economic value see their stocks go up over time. This is the most powerful correlation in the markets, and for good reason...

A company that grows earnings 10% per year may double over time... But wouldn't you rather find companies that can grow their earnings 100% to 5,000%?

To find big returns, look for companies with big economic growth.

Take online-dating company Match Group (MTCH), for example. Match runs the world's leading online-dating services and includes brands like Tinder, OkCupid, Hinge, and more.

Considering that practically everyone on earth is interested in finding a partner, and almost everyone already has (or will one day have) Internet access, that's a total addressable market of more than 7.5 billion people. Cutting that in half to exclude children, married folks, etc., that's around 3.3 billion singles.

At the end of 2020, Match had nearly 11 million paying customers. And we know the company has plenty of room to grow.

  1. The Common-Sense Test

It's not always that simple, though. Many companies out there have the potential for huge economic upside.

One that has dominated the press in recent years is WeWork...

The company argued that its end markets – commercial real estate – were massive. Prior to the COVID-19 pandemic, commercial real estate in the U.S. was worth more than $15 trillion.

In 2018, before its disastrous initial public offering collapse the next year, WeWork generated $1.8 billion in revenue... or 0.00012% of the U.S. market! If it could capture even half a percent of the U.S. market, its revenue would go up more than 400,000%.

That's the definition of huge economic upside.

There was one big problem, though: WeWork's core business model simply didn't make any economic sense. The company made $1.8 billion in revenue but lost $1.9 billion (and burned even more cash than that).

Since you don't need to own lots of stocks to be profitable, why would you waste your time and money on companies like WeWork? Why not find companies with huge economic upside that are already making money?

  1. Positive Operational Momentum

We also want to see companies that are both growing and exceeding Wall Street's expectations.

It's impossible to know exactly how good a company's management is. But if the company is growing and beating expectations, then management is showing it can succeed.

When we say "positive operational momentum," we're looking for positive earnings revisions in a majority of the quarters over the previous two years. In the following two charts, you can see historical revisions for both revenue and earnings per share ("EPS") for Match...

Again, you can see that over time, Wall Street analysts had to keep upping their estimates to keep pace with Match. And Match continues to beat them. With time, that has led to big gains in the stock.

  1. A Strong Long-Term Trend

The 250-day moving average ("DMA") is a good way to gauge a stock's long-term trend and positive price momentum. With roughly 250 trading days in a year, the 250-DMA is essentially the 12-month moving average. It shows long-term trends.

A 250-DMA on the rise shows us that the market is responding to a company's value creation and that you have a good balance of buyers versus sellers.

Here's a long-term chart for Match, plotted alongside its 250-DMA...

It doesn't take a genius to see that Match's 250-DMA goes from the bottom-left corner to the top-right corner. In other words, the long-term trend is up.

So, in conclusion... why try to figure out when a stock will go from long-term disliked to liked, when we can find a smaller number of stocks at any given time that we know the market likes?

Look for stocks with big economic upside that pass the common-sense test, continue to beat analyst expectations every quarter, and have a strong long-term trend... These are the companies that can produce huge returns in the market over time.


Enrique Abeyta

Editor's note: Enrique has identified what could be the best recommendation of his 25-year career. This stock is a "backdoor" way to capture the upside of cryptocurrencies... without owning a single crypto. And several tailwinds are setting up to drive its share price sky-high. In fact, Enrique says it's positioned to turn every $10,000 into $110,000 over the next few years. You still have time to get in before the biggest gains are over... Get the full story here.