How to find the next 10 bagger (Part VI)

A series of articles examining past 10 baggers.

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In this series of articles, I am taking a look at the history of some of the ASX's best performing stocks. In particular, I hope to address the following questions.

  1. What did these companies look like at the start of their rise?
  2. Is it possible to identify tomorrow's 10 baggers?

Online property classifieds business REA Group Limited (ASX: REA) has been one of the ASX's top performers over recent times. The shares have been rising on a virtually uninterrupted trajectory for well over 10 years. If you had been farsighted enough to pick up $10,000 of shares back in April 2003, then you would be sitting on an asset worth $2.5 million today, plus you would have received $120,000 in dividends.

In April 2003 realestate.com.au, as REA Group was called back then, had recently announced its half year financials. Revenue grew 28.9% to $4 million for the half and although the company reported a loss, operating cash flows were positive. The divergence between cash flows and profits was caused by a depreciation charge relating to advertising services provided by News Limited in return for shares issued in 2001.

More importantly, realestate.com.au was the outright leader in the Australian online real estate market on numerous measures by the start of 2003. For example, in January 2003 it recorded 677,000 unique visitors to its site, more than its two nearest competitors combined.

The company had a market capitalisation of $22.2 million in early 2003 making it a true microcap, but it could be argued that the stock was expensive at this price given the business was barely profitable. However, several half years of consecutive growth up to the first half of 2003 in both sales and earnings before interest, tax, depreciation and amortisation (EBITDA) suggested a bright future for the company.

John Niland was the chairman of realestate.com.au in 2003 and acquired almost 100,000 shares on market at the end of 2002 in a show of confidence in the company's future. The fact that Ray White Real Estate, NineMSN and News Limited all had significant ownership interests at the time further hinted at the potential of the company.

Undoubtedly one of the best quality businesses on the ASX today, REA Group was an unprofitable microcap in 2003 that most people would have considered too speculative to invest in. Of course, most of the time it is the correct decision not to invest in these types of businesses because they end up destroying shareholder value. However, realestate.com.au stood out from the crowd because of the quality of its shareholder base and the fact that it was the market leader in a high growth segment.

Emerging trends

Having looked at six 10 baggers so far, some trends are emerging.

  1. All six had market capitalisations of less than $100 million
  2. In five out of six cases, board members were buying shares on market
  3. All six companies were and still are scalable businesses with competitive advantages operating in growing markets
  4. In five out of six cases, headline profit figures from recent reports understated the company's true ability to generate free cash
Motley Fool contributor Matt Brazier has no position in any stocks mentioned. The Motley Fool Australia has no position in any of the stocks mentioned. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. This article contains general investment advice only (under AFSL 400691). Authorised by Bruce Jackson.

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