How you could turn $1,000 into $10,000

published 3 October 2007

Even the most level-headed of investors dream of buying a share that makes them really rich in a hurry. The good news is there are strategies to improve your chances of doing so. Peter Lynch came up with the ten-bagger concept in his book One Up On Wall Street, and others have elaborated on it since. Here we look at some ways to find stocks that can potentially turn £1,000 into £10,000.

The investment approach

Investors Chronicle's David Stevenson recommends looking for shares that have seen strong share-price growth which suggests the company, too, is growing fast. Ideally, you want a firm whose growth puts it in the top quartile for the market. But while this shows the share has momentum, it doesn't tell you anything about the underlying business so you also need to do some quality checks. Firstly, the firm's products must be in demand look for 25% or more top-line sales growth in the past year. Secondly, those sales must be profitable you want consistent net profit margins (profit after tax as a proportion of sales) of 10%-15%, along with a return on total capital employed (operating profit divided by long-term balance-sheet debt and shareholders' funds combined) of at least 10% for the past two years.

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The next step is to look for a decent trend in earnings, not just the share price a good guide is whether the company achieved earnings per share growth (net profits divided by the number of ordinary shares in issue) of at least 10% per year and ideally closer to 20% for the last 12 months. But you don't want to overpay for this growth a price to earnings growth (PEG) ratio of less than one is a useful rule of thumb.

Other good indicators include directors owning at least 10% of the company. There's nothing like shared ownership to focus the management team's attention on the same goal as yours raising the share price. Also remember that cash is king' take a look at the cash flow statement and see whether operating cash flow (near the top) covers capital expenditure and also any ordinary dividends further down. This is important because too many small businesses grow quickly but then go bust having forgotten about the mundane, but critical, tasks of collecting and managing cash.

You could also look for small companies that may not fit all the criteria above, but that have huge potential. Tom Bulford of Red Hot Penny Shares likes the look of engineer Corac (CRA), which has developed an air compressor that can vastly improve yields and efficiency in gas wells. It is being tested by gas majors next year; if successful, a 1% share of the market could be worth £750m. Corac's current market cap is just £35m. Falkland Oil and Gas (FOGL), meanwhile, has licences covering a vast tract of the south Atlantic ocean. One survey suggests there could be at least 10 billion barrels of oil in the region. The £146m market cap firm is currently in talks with an oil major that may finance a drilling campaign. Bulford also likes Braemore Resources (BRR), a £62m market cap nickel miner that could be sitting on $8bn worth of the metal at current prices.

How does a company get promoted or demoted from the FTSE 100? Each quarter, the FTSE Group identifies the top 100 firms from a full UK listing, ranked biggest to smallest by market capitalisation. The calculation is based on the number of ordinary shares issued by each firm multiplied by the share price, but with a twist free float. There is no point including even huge companies, such as Russian oil giant Rosneft, if few people can buy their shares. So the market capitalisation for this type of firm is adjusted downward, with penalties starting for companies where anything less than 75% of their shares can be bought or sold by the investing public.

There are also rules to stop too many companies just above, or just below, the bottom of the list from being bounced in and out on the strength of small quarterly changes in market capitalisation. A company aiming to join the top 100 needs to be big enough to rank it 90th or higher when the quarterly review is carried out; one already on the list would need to have suffered a drop in market capitalisation great enough to rank it at or below 111 before it is ejected and joins the FTSE 250 instead.

Tim graduated with a history degree from Cambridge University in 1989 and, after a year of travelling, joined the financial services firm Ernst and Young in 1990, qualifying as a chartered accountant in 1994.

He then moved into financial markets training, designing and running a variety of courses at graduate level and beyond for a range of organisations including the Securities and Investment Institute and UBS. He joined MoneyWeek in 2007.