In order to invest in what Peter Lynch calls “Tenbaggers” (stocks that increases 10 times from your initial purchase) you should look at companies that have superior earnings power. In other words, if you want to generate triple digits and grow your portfolio in a meaningful way, you should look at companies with incredible products, entrepreneurial management teams and potential new product releases. In this article I will cover three companies that show interesting competitive advantages that will enable them to achieve long-term success in promising and growing markets like electric vehicles, smartphones and innovative consumer devices. While I think these companies are unrelated, I am sure they have specific key drivers in common: superior earnings potential and a growing market share. Let’s go and look for Tenbaggers!
Could Tesla be the Apple of Automobiles ?
Tesla Motors Inc (NASDAQ:TSLA) is an electric vehicles and components manufacturer that has been performing very well in the past year, and extremely well in May. On May 8, it reported positive earnings for the first time in its history, with an EPS of $0.12 that beat analyst estimates of $0.04 and generated a positive market reaction that drove the company to a market capitalization of $8.7 billion, surpassing Fiat’s market cap of $7.7 billion. To a great extent, this price increase is driven by short sellers covering their positions after the positive surprise earnings. Tesla Motors Inc (NASDAQ:TSLA) is one of the most shorted stocks in the Nasdaq, with a short interest, comprised of a significant portion of naked short positions, of approximately 40% of Tesla Motors Inc (NASDAQ:TSLA)’s float. But to a certain degree this price action reflects improved fundamentals and growth prospects. Tesla Motors Inc (NASDAQ:TSLA)’s Model S received outstanding reviews, and efficiency gains and increased margins all positively contributed to the bottom line.
I think that Tesla Motors Inc (NASDAQ:TSLA) will succeed in the long run because it is in the way of moving from a niche luxury market (Model S/X) to a mass affluent segment (upcoming model Gen III), a strategy that could mean exponential future profits. In addition, the company has been improving its balance sheet and offers customers the possibility of owning a Tesla Motors Inc (NASDAQ:TSLA) for just a $400 monthly payment from a newly released lease buying program. These kind of “high growth plays” are very hard to analyze from a value-investor perspective: for example, who could have predicted that Apple’s 2004 P/E of 60 will end up being cheap because the company will release the iPhone and iPad some years later? A similar case happened with Amazon in 2004, as the company has been trading at high multiples since the stock became public, but the stock keeps rising.
Forward looking, the stock should be able to produce a model costing just $35,000 in about three to four years. In addition, Tesla plans to dramatically expand its electric-car charging network and could partner with Google to develop self-driving electric cars. While the stock is extremely expensive at this time, I think that it is one of the companies that has the biggest room for appreciation in the coming years. Some Bulls even think that the stock could trade to $300 as the company keeps expanding and delivering double-digit earnings growth.
Although I like Tesla as a business, and I am bullish on the long-term prospects of the stock and of the electric vehicles industry, I consider that the market overreacted to the quarterly earnings surprise and that there is potential for a price correction once the short squeeze is resolved. In other words, I like this stock as a long-term holding, but I would be extremely cautious in the short term because a sudden correction could be very close.
I think that a conservative way of playing this stock is buying the just released Convertible Bonds, which pays a meager 1.5% interest but offers material appreciation if Tesla’s strategy succeeds. The worst you can get is receiving your money back after 6 years and collect a tiny interest while watching how equity investors suffer.
Upside potential from the smartphone market
ARM Holdings plc (ADR) (NASDAQ:ARMH) is a semiconductor company that designs microprocessors, and that also operates other related business lines such as intellectual property, and software and development tools. In contrast to other microprocessor companies such as AMD and Intel, ARM Holdings plc (ADR) (NASDAQ:ARMH) does not manufacture its own CPUs, but rather sells licenses of its technology as Intellectual Property to chip makers, which in turn adapt the designs to their specific needs. This means that ARM Holdings plc (ADR) (NASDAQ:ARMH) operates a “light” business model, which does not require significant capital expenditures to succeed. For example, Intel Corporation (NASDAQ:INTC)‘s CapEx represents 61% of its operating cash flow, while ARM Holdings plc (ADR) (NASDAQ:ARMH) pays its CapEx with just 11% of its OpEx cash flow.
ARM Holdings plc (ADR) (NASDAQ:ARMH) technology is being used in a wide range of end products, from very simple products such as automobile keyless entry systems, garage door openers, toys, to more complex systems such as smartphones and tablet computers, which provide the largest source of revenue. For example, Google’s Android operating system runs on chips designs using ARM Holdings plc (ADR) (NASDAQ:ARMH) technology.
Key to ARM success is the low-cost and energy efficient designs. ARM closed on May 10 at $49.59, achieving a return of 104% over the past year. The bullish trend might continue, as the fundamentals of the company look bright. ARM´s operating margin of 30.3% is ranked higher than 98% of the 622 companies in the Global Semiconductors industry, well above the industry median of 2.6%. Its net margin of 22.9% and revenue growth of 11.9% both point out to a healthy environment that justifies high valuation multiples. In fact, ARM is trading at a P/E of 85x, which is well within the range it traded over the past 3 years. In other words, in terms of multiples, ARM has traded at a higher valuation in the past.
Forward looking, the company is positioned to keep its solid performance across all the business lines. The growth in the company’s V8 architecture licensing has been extremely good and ARM’s partners are adopting the company’s 64-bit architecture in a big way for servers and networking products. According to Barron’s, Intel Corporation (NASDAQ:INTC)’s Atom takes three times the number of transistors to implement functional blocks that perform similar workloads, a sign of being less efficient than ARM-based designs. In addition, the Intel x86 architecture uses the “variable length instruction word” approach, making it harder to streamline aspects of what are “monolithic” server processors. This is the key advantage that will make ARM keep performing well in the future.
I think that ARM is well positioned to hold a leadership position in the smartphone and tablet market. In a recent report, Canaccord Genuity analyst Matthew Ramsay projected that ARM share in microprocessors will increase to 50% from 32% at present by the end of the decade.
Great growth opportunities for Ambarella Inc (NASDAQ:AMBA)
Ambarella Inc (NASDAQ:AMBA) is a leading developer of semiconductor processing solutions for video that enable low-power, high-definition, video capture, sharing, and display. This company went public on October 2012, yielding to date a 136% return to reach a market capitalization of $387 million. Ambarella Inc (NASDAQ:AMBA) technology is being increasingly used in a variety of HD cameras including security IP-cameras, wearable sports cameras, digital still cameras, and automotive video recorders. The company is an established market leader in video content creation and is leader in sub-segments such as IP security camera, automotive cameras and sports cameras. I think that video processing applications or devices face no competition from video enabled smartphones.
Although Ambarella Inc (NASDAQ:AMBA) is a relatively unknown firm, with only four analysts covering the stock and a short financial history to use as a reference, growth and profitability numbers look promising.
Revenue growth was 24.5% for the past fiscal year to total $121.1 million, and is expected to grow at a similar pace in the foreseeable future. Gross margins are stable at 66.6%, net profit margin was 15%, and Ambarella Inc (NASDAQ:AMBA)’s balance sheet shows a strong position with no debt, and cash and cash equivalents of $100 million. EPS consensus estimate for the next fiscal year is $0.84, which implies a 40% EPS growth. In spite of the expected high EPS growth, Ambarella is trading at a reasonable P/E of 22x, which makes it appear relatively cheap given its high growth potential.
Forward looking, I believe that Ambarella Inc (NASDAQ:AMBA)’s growth could come from the security market, which is migrating from analog standard definition to IP HD cameras. Ambarella Inc (NASDAQ:AMBA) offers security products that are superior to its competitors and this category should be one of the future growth catalysts of this company.
I like how the company is positioned in the automotive and sports camera markets. In addition, Ambarella’s CEO Fermi Wang was very bullish on how Ambarella will grow in the IP security camera market. He explained that the security market is under a secular migration from analog standard definition cameras to digital, IP-based high definition cameras. This is the kind of technology that Ambarella does best and security cameras represent just 10% of the company’s total revenue pie. This security camera segment represent strong potential growth.
My Foolish conclusion
To summarize, I recommend buying Ambarella and ARM, and buy Tesla Convertible bonds to hold them for the long run as the shares could face material volatility in the near future.
The article Are You Ready To Invest in Tenbaggers ? originally appeared on Fool.com.
Victor Selva has no position in any stocks mentioned. The Motley Fool recommends Tesla Motors . The Motley Fool owns shares of Tesla Motors. Victor is a member of The Motley Fool Blog Network — entries represent the personal opinion of the blogger and are not formally edited.
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