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Undiscovered Growth Stocks

Chapter 4 of my Little Book is devoted to what I call undiscovered growth stocks:Growing Out of Sight: Finding Undiscovered Growth Stocks

What are they?

Nothing gets a Wall Street heart pounding like the phrase growth stock. There is a good reason for this. If you can find a great growth company in the early phases of its journey, you can make enormous amounts of money just by sitting still.

What you need to know

When looking for undiscovered growth stocks we have to think a little differently. We do not necessarily want to own the most popular exciting stocks. These are the stocks you hear folks talking about around the water cooler at work. These companies tend to have cutting-edge technologies or products that everyone is excited about. (Can you say Apple?) These are not the type of stocks we are looking for when we search for low-priced stocks with breakout potential.

If everyone likes them and already owns them, they are probably pretty high in price and much of the gains are already discounted in the price. Legendary investor Sir John Templeton once pointed out that it is hard to outperform if you do what everyone else is doing. During the California Gold Rush a few miners got rich, but many more went bust. Almost all of those who went to the territory with the idea of selling supplies to the miners did very, very well for themselves. It might not have been as exciting, but it sure was profitable.

Famed Example (not featured in book). Magic Software (MGIC)

One of the reasons Magic Software (MGIC) is undiscovered is that it is based in Israel, and Wall Street often misses smaller international companies. Magic is an information technology (IT) company that helps its customers develop and deploy their business applications, streamlining processes and increasing efficiency as a result.

The company makes money through its software, as well as consulting, maintenance and technical services, including things like annual maintenance contracts and technical support services.

Video To Watch

Pick up a copy of my Little Book and use your tablet device or smart phone to scan the QR code inside Chapter 4 to get my newest undiscovered growth stock recommendation.

I got interested earlier this year because MGIC is in the midst of an impressive turnaround and has recently increased its offerings in the key areas of cloud and mobile applications. In fact, Magic says mobile technology is the fastest-growing area of software development in the world (all we needed to see was the incredible hype recently over the iPhone 5 to be reminded how true that is), and its applications help enterprise users connect to core systems from their mobile devices.

The Turning Point

MGIC has grown its consulting business significantly in recent years through several key acquisitions. In 2010, Magic bought two consulting and staffing services firms for $15.3 million, and on January 1 of this year, Magic acquired a 51% interest in its South African distributor for $2.5 million.

The 2010 acquisitions in particular gave the company a significantly different revenue base, with consulting service revenues more than doubling from $24 million to $54 million. Results were also aided by higher software revenues, as demand recovered after the recession. Total revenues increased 60% to $88.6 million, and margins expanded on the higher revenues. Earnings increased from $0.19 a share in 2009 to $0.29, also aided in part by a tax credit.

Those acquisitions have continued to bear fruit, as the company reported record-breaking net profits in the second quarter of 2011. Revenues, helped by the strategic acquisitions, increased 27.5%, the seventh straight quarter the company had revenue growth of 10% or more.

This is the kind of opportunity to go after in today’s market. It’s a solidly performing company with improving financial results and a demonstrated ability to grow its software product and integrate acquisitions. Plus, it helps companies operate more efficiently, a service that will become even more important as costs continue to increase. It’s strong cash position also helps lessen risk in a slow-growth economy.

MGIC has come down in the recent market volatility to around $4, where I view the stock as an incredible bargain with excellent long-term potential.

What’s makes this one an undiscovered growth stock?

MGIC is trading below $10 and has strong earnings growth. Look at some of these highlights from its second-quarter earnings report:

• Sales increased for the seventh straight quarter, jumping 27.5%.
• Net profits hit all-time highs, increasing 84% over the prior year to $3.5 million.
• Earnings of $0.086 a share were up 34% from the previous year.
• The stock is trading at just 10X the reasonable estimate of $0.40 a share for 2012.
• Magic has $1.20 a share in net cash, nearly 30% of the current stock price.

Pick up a copy of my Little Book and use your tablet device or smart phone to scan the QR code inside Chapter 4 to get my newest undiscovered growth stock recommendation.