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As we continue to trawl for long term dividend payers that can be the core of a long term investment portfolio, Adam Wiederman of the Motley Fools looks into how you can find your next big winner. While I am cautious about finding a "big winner," it's not a bad idea to have some of your investments assigned to something that might turn out to be the next Apple -- although it can turn into the next no-name company that died in onscurity.

Adam mentioned eBay (NASDAQ:EBAY), Amazon.com (NASDAQ:AMZN), and Netflix (NASDAQ:NFLX) as companies who created and then dominated their niches. Once that was done, they started expanding into adjacent niches, challenging the giants in a way that many didn't see coming. I remember hearing a presentation by Netflix CEO where he talked about not following the crowd because they are not always right.

This is all fine so far and I know that each of these companies have many fierce detractors but I am going to follow the line of thinking and look at his two selections of companies with this potential.

  • The first, OpenTable (NASDAQ:OPEN), has the potential to revolutionize aspects of the restaurant industry. It currently sells electronic reservation software to restaurants and has a growing online reservation-taking platform that syncs up to a restaurant's books.
  • The second company, Rackspace Hosting (NYSE:RAX), was an early pioneer in managed server hosting. Now, it's successfully added on to that by offering cloud hosting as well.

As I look at these two companies I have some hesitation.

OpenTable doesn't sell anything, and is a free service to the public, so it doesn't have the business experience to sell something directly to the public. I agree that there are many areas of expansion -- discount coupons, reservations for other types of businesses -- but I don't see a big, long term bang.

Rackspace Hosting will have their hands full competing with the likes of Amazon and Apple in cloud computing. There is the potential for them to expand and there is serious money in hosting -- I am not sure where they go from here -- but that's the trick.

So, while the approach is finding companies who can dominate a niche and expand from there into other niches, I am not sure that either of them fit this bill.

It's certainly worth measuring their performance against the dividend-bearing ETFs.

AssetFund in this portfolio
REAL ESTATE(NYSEARCA:ICF) iShares Cohen & Steers Realty Majors
CASHCASH
FIXED INCOME(NYSEARCA:TIP) iShares Barclays TIPS Bond
Emerging Market(NYSEARCA:VWO) Vanguard Emerging Markets Stock ETF
US EQUITY(NYSEARCA:DVY) iShares Dow Jones Select Dividend Index
US EQUITY(NYSEARCA:VIG) Vanguard Dividend Appreciation ETF
INTERNATIONAL EQUITY(NYSEARCA:IDV) iShares Dow Jones Intl Select Div Idx
High Yield Bond(NYSEARCA:HYG) iShares iBoxx $ High Yield Corporate Bd
INTERNATIONAL BONDS(NYSEARCA:EMB) iShares JPMorgan USD Emerg Markets Bond

Portfolio Performance Comparison

Portfolio/Fund NameYTD
Return
1Yr AR1Yr Sharpe3Yr AR3Yr Sharpe5Yr AR5Yr Sharpe
Retirement Income ETFs Tactical Asset Allocation Moderate0%0%22%9%78%7%59%
Retirement Income ETFs Strategic Asset Allocation Moderate5%3%37%17%125%2%12%
RAX4%68%136%45%71%
A Contrary Way to Find Your Next Big Winner22%-1%-2%
OPEN10%74%150%

As we are only talking about two companies, I thought I would report them individually as well as combined. In the table above, I have the combination of both stocks in between the two stocks. This is shown in the graphs under "A Contrary Way to Find Your Next Big Winner" -- the red line below.

I think when you are down to only two, the hedging impact may not apply. Unfortunately the table doesn't work well because OPEN has just less than three years of history, which means that we can't really look at the bigger picture. As far as the table goes, it looks like we have strong contenders but I think it is misleading. We do have the graphs and we are going to rely on them.

Three Month Chart One Year Chart Three Year Chart Five Year Chart
Using the five year chart, I am disturbed by the drop in OpenTable's value. To be a next generation winner, you have to be on a strong up-and-to-the-right trajectory that enables your brand to be established so that you can grab on to the next thing that will be the secondary booster.

My first filter would throw out OPEN, as I think having a free service in a business with tight margins is not a strong starting point. Then I look at the performance, and I think that would give me pause, in any case.

RAX remains interesting, as there is a move to outsourcing, and if they are primarily focused on just that, they will likely be more responsive than the big guys, and I think there is enough of a business here to grow into something substantial. It is very difficult to grab that second thing that takes you further. eBay purchased a lot of companies, and PayPal is the only one that stands out. I know that it's possible to buy great looking companies that fizzle once inside the mother ship.

Selecting "the next big thing" is always going to be a high risk/high reward strategy and should be approached with caution. It might be worth keeping an eye on RAX, especially if and when they talk about buying other companies.

It's valid to say that very successful companies first dominate their niche and then expand into other areas and take on established companies. This is a good filter for that -- however, it is very hard to pick those companies, and I wouldn't bet that RAX and OPEN will be one of them. They may be successful, but the next big winner -- I don't think so.

More analysis...

Disclaimer: MyPlanIQ does not have any business relationship with the company or companies mentioned in this article. It does not set up their retirement plans. The performance data of portfolios mentioned above are obtained through historical simulation and are hypothetical.

Source: A Contrary Way To Find Your Next Big Winner