Review: Finding the Next Starbucks

next starbucksA while back, I read Louis Navellier’s The Little Book That Makes You Rich, which was intended to serve as a simple introduction to growth investing. For those unfamiliar, growth investing means that you seek out and invest in individual stocks that show distinct signs of growing rapidly over the next few years – think Google or Starbucks in recent years.

I don’t particularly plan to invest a lot in individual stocks in the near future, as I’m primarily focused on paying off debts. However, I am quite interested in and trying to learn as much as I can about individual stock investing and the strategies one uses in picking, buying, holding, and selling individual stocks. Navellier’s book was my real introduction to the growth strategy and the ideas stuck in my head and bounced around in my thoughts until I just had to find a book that discussed modern growth investing for the individual investor.

That led me straight to Michael Moe’s Finding the Next Starbucks. It basically focuses on how to spot companies in their early growth phase, theoretically enabling people to invest at the IPO or shortly after in companies like Home Depot, eBay, Dell, Google, Starbucks, and so on. In other words, it focuses on a flavor of growth investing that seeks to find companies early in their growth curve.

Finding the Next Starbucks was recommended to me by several people as a great book to look at for a modern growth investment strategy, and they professed it to be well-written and easy enough to understand while laying out a strong strategy. Does the book actually live up to this hype? Let’s find out.

Looking Into Finding the Next Starbucks

1 – Star Search: Finding the Supernovas
Moe opens the book by arguing that the most lucrative investment opportunity available to investors is identifying and buying into a small company that has the potential to grow into a big company. If you can latch onto one of those, not only can you ride the actual growth of the company, you can also ride the surge of the herd of investors buying into the stock as it rises into the stratosphere, pushing the price up even more. This chapter is mostly just filled with specific examples of spectacular growth stocks, like Home Depot and Starbucks. In short, he makes the case that, indeed, growth stocks are a good investment if you can get in on that ground floor … but how do you do that?

2 – The Power of Growth: The Magic of Compound Interest
Here, Moe just reiterates the astonishing power of compound interest, showing that when you have the opportunity to ride a rocket ship for a number of years, sitting on a stock that sees very nice double digit annual returns, your actual profit will be enormous. It’s a fairly simple concept to those familiar with personal finance, but it’s quite important for your investments.

3 – High Earnings Per Share = High Internal Rate of Return (the Argument)
At this point, Moe makes it clear that he is trying to distinguish between growth stocks and growth companies. Growth stocks are merely ones that show signs of having a premium value for some reason, while growth companies are companies that show signs of entering (or being in) periods of rapid growth. Basically, most of the time, growth companies are a particular subset of growth stocks, and they’re a subset that he’s interested in. How do you find them? Moe identifies the biggest factor as being a high earnings per share, meaning that the company earns a lot of money compared to the number of shares of stock available for purchase for that company.

4 – Formula for Identifying and Evaluating the Stars of Tomorrow (the Process)
Here, Moe talks about the things he looks for in identifying a great growth company. For the most part, these factors are intangibles – ones that you can’t really break down into numbers. For example, he looks for companies that have great people (particularly great management) and also companies that are poised to take advantage of megatrends, or major shifts in society or industry. In other words, Moe looks at the company itself, not a numerical representation of the company found on the stock page.

This concept reinforces a fact that keeps popping up again and again in the books I read about individual stock investing: homework pays off. The people that manage to beat the market with individual stocks are the people who are able to invest the time and have the passion to do the research and find these good companies and good stocks to put their money in, and they have the mental attitude to stick with it through bumps and downturns.

5 – Megatrends
So what are these “megatrends” that Moe talks about? He spends about a hundred pages here identifying and looking carefully at a wide array of megatrends that he sees coming in the future. Now, to a degree, this material is pure speculation on Moe’s part, but he makes a compelling case for each one.

Moe’s biggest megatrend is the increased reliance of the U.S. economy on knowledge workers, ones that bring a specialized but important set of skills to the table. He looks to companies that provide IT services and health care as being industries that really benefit from this megatrend. In fact, he keeps going back to these two industries as ones that will see exceptional growth in the coming decade, because they fit a lot of his megatrends.

6 – The Four P’s
Finding the Next Starbucks identifies four P’s as being vital clues as to the growth forecast of a company:
People – does the management team have a plan in place and the skill to move that plan forward?
Product – is the company providing a product that is compelling?
Potential – does that product have a lot of room for growth in the current marketplace?
Predictability – is it easy to see where and how this company’s growth will occur?

I thought of Starbucks when reading about the four P’s. It was pretty clear that they had the people, the potential, and the predictability, but I’m not sure I would have believed in the product outside of the coffee-happy Pacific Northwest.

7 – Valuation Methodology
This chapter dove pretty deeply into the math of what a particular company should be valued at, which is useful when you’ve found a growth company and are considering buying. Moe’s math is fairly complex, but in a nutshell it relies on the company’s P/E ratio and the value of a ten year treasury bill. It makes sense, as it uses the status of the treasury bill as an indicator of where it makes sense for investors to put their money – if the t-bill has a low return, investors are going to be more into the stock market, thus you can expect to pay a higher price on a stock when the t-bills are low than when they’re high. He almost insinuates that the time to hunt for good deals is when t-bills are high, but doesn’t quite make it.

8 – Sources and Resources: Finding Ideas
Finding the Next Starbucks repeats the “homework, homework, homework” mantra here. Moe gives a long list of the resources he uses to find ideas and companies that may be poised for breakout success. For the most part, I think his list is pretty mainstream and expected – he tracks some of the most high-profile investment papers and websites and a few top blogs, as well as keeping some very close tabs on the actions of some venture capital companies (by searching Google News and likely Google Blog Search, too).

If I were doing this, I would likely pick a specific sector or two and know that sector cold. If you spent time following Moe’s ideas, you should find yourself with a handful of sectors to concentrate on. Dig deep into those sectors and look for companies that are making waves. To a degree, Moe’s resources show that he does this, but he doesn’t explicitly mention it.

9 – Think Tomorrow, Today: Hot Areas for Future Growth
Earlier in the book, I was fairly frustrated that Moe didn’t explicitly discuss specific sectors and how they related to his identified megatrends. He gets around to that here, and it makes some sense why he kept them separate – these sectors and individual companies are like surfers on the waves of megatrends – some of them will catch the wave and ride it to success, while others will fall off the board and land flat on their face. That’s what the four P’s are about – trying to figure out which is which.

Most of the sectors Moe identifies here are either directly related to the internet and communications or are connected to health care, both of which are unsurprising. While his sectors make sense, in some cases he misses out on the individual company lists. For example, he excludes Apple from the list of companies that would ride the cell phone sector, but when Apple dropped their iPhone in 2007, their stock doubled in a year. I think Moe’s sectors make a ton of sense, but do your own homework when looking for individual companies.

10 – Case Studies
Moe closes the book by looking at a bunch of case studies, either examining specific companies or comparing two companies within a sector (like AMD and Intel). He repeatedly uses the methods from the book, tying the sectors to megatrends, then identifying the four P’s within the evaluated organizations. When two companies are compared, he usually concludes that one is poised for more growth than the other, and he’s pretty good at it – he predicted that Best Buy would continue to outgrow Circuit City and now Circuit City is having some serious problems, for example.

This was actually the best part of the book for me because more than most personal finance books, Moe actually effectively tied everything he talked about earlier in the book into real-world examples that could be followed and comprehended. It took a book that I was rather wishy-washy about and turned it into a book I quite enjoyed, because I found myself flipping back, rereading earlier parts, and really getting a better understanding of the whole book.

Buy or Don’t Buy?

There are parts of this book that are dry and boring, and there are a few instances where Moe seems to have an ego. For much of the book, Moe seems to be talking in terms of concepts that are hard to describe in concrete black-and-white terms.

That sounds like I’m going to slam the book, but I’m not: Michael Moe’s Finding the Next Starbucks is actually a very good read if you want to learn about how to invest in growth companies. More than any stock investing book I’ve ever read, Moe takes conceptual elements, builds on them, and then shows how they really apply to real stocks.

Bear with the slow parts: eventually, the book gets around to tying these all together into a very sensible package. I found myself quite bored during the Megatrends chapter, for instance, but later on the ideas presented there seemed a lot more concrete, interesting, and applicable. Stick with it, and this book will be well worth your while.

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24 thoughts on “Review: Finding the Next Starbucks

  1. Tom says:

    I invest mostly in Berkshire Hathaway because Buffett seems to know exactly what he’s doing.

  2. Minimum Wage says:

    Product – is the company providing a product that is compelling?

    Since when is overpriced coffee a compelling product?

  3. Heidi says:

    @MW: It’s not the coffee that’s compelling – it’s the whole idea of “the third place.” People will pay ridiculous amounts of money for the “privilege” of having use of space that isn’t work and isn’t home.

  4. Tom, Me too. All my money is in index funds except for one BRK B share.

    As for the book, it sounds like the growth version of “Rule #1″ by Phil Town, which focuses more on Value Investing. Especially with the emphasis on homework, management, and product (Town calls it a “moat.”).

    Sounds like a worthwhile book.

  5. Tom, Me too. All my money is in index funds except for one BRK B share.

    As for the book, it sounds like the growth version of “Rule #1″ by Phil Town, which focuses more on Value Investing. Especially with the emphasis on homework, management, and product (Town calls it a “moat.”)

  6. Jason says:

    I always enjoy reading the books you recommend. Thanks for taking the time to publish your unbiased reviews. My nightstand looks a lot like your “Recommended Reading” list!

    Like you, I don’t have much money or inclination to invest in single stocks. However, I think it’s a great idea to familiarize yourself with investment concepts so when we are blessed with cash we know what to do with it.

  7. Success in personal finance boils down to leverage. With investing, the leverage of knowledge is powerful, especially if you want to make the most efficient use of time.

    To be brief, the attempt of “beating the market” is futile, especially with large-cap stocks. “Finding the next Starbucks” implies digging into small-cap stocks, which is a more prudent pursuit but requires a great deal of time and energy. I suggest leveraging the wisdom of others by looking at a mutual fund company, such as Royce Funds, that specializes in small-cap stocks.

    Why not let someone else find the next Starbucks and enjoy your life at the same time. Now that’s’ efficient!

  8. The Chef says:

    Well, all my money (whatever small amount surplus I have) is invested into direct equities or what you call as individual stocks.

    Investing in individual stocks is risky as compared to mutual funds as they are well diversified and the fund manager plays with the companies to invest in on a regular basis. But the returns are pathetic as compared to individual stocks.

    My approach: Find a high growth sector e.g. energy , power, infrastructure etc. you would see daily reports of sectoral growths in magazines and newspaper. Make sure you understand that sector well. Now find the various companies operating in that particular sector or any IPO of such company.

    Then find an undervalued company in that sector and then buy it. its 99% work/research and 1% trading. And you have a winner at your disposal.

    @ The Financial Philosopher, I would say it’s not efficient because you lose control of your money where it’s invested, I not talking about funds here but the companies that you wanted to invest.

  9. Peter says:

    Okay, the ultimate question. Has Moe gotten rich doing what he’s saying you ought to do, and has he provided evidence to back it up? Or is he making his money by selling advice in telling people what to do to get rich?

    I didn’t see anything in the review that explained how he made money following his own analysis and advise. He follows a bunch of sectors, but there’s no scorecard to let you know how he’s doing. So he is essentially acting like a Monday morning quarterback.

    Based on his bio for ThinkEquity partners, he’s more of a teller on how to get rich than a doer at getting rich (in that he’s not necessarily getting rich by “Finding the Next Starbucks”). While there’s really nothing wrong with that, it does mean you need to look at his recommendations more as a guide based on past performance, rather than a method the author actually used to gain his wealth.

  10. I like to hear about ideas like this and The Motley Fool, but if you look around there’s not a lot of people who have had great success doing this. Like the first comment says, I would buy class b shares of Berkshire Hathaway first (if only a single share wasn’t worth more than my investment accounts!).

    Some day when I have spare savings it would be fun to read this and subscribe to the Fool’s hidden gems newsletter to play the game little, but even if you’re betting on the best growth companies some of them will just have bad luck. Even assuming you’ll get the best may be a stretch. I’ll admit the possibility that a portfolio of investments in small growth companies could give you a good return, but getting the right portfolio is probably much harder than it sounds.

    The last part of the book sounds suspicious too; it might have a little value as a way to demonstrate the important points in growth companies, but anyone can see which companies did well in the past. Trying to promote a strategy by saying you know which companies have done well in the past might be a sign that the only thing going for it is obvious and useless facts.

    I would also look at the things he finds successful companies have in common with caution. What’s the success rate if you look at all companies with those attributes – including the ones that imploded years ago and were quickly forgotten?

  11. mike says:

    You say, “However, I am quite interested in and trying to learn as much as I can about individual stock investing and the strategies one uses in picking, buying, holding, and selling individual stocks.”

    I would suggest reading William O’Neal’s books. Yes, the cover artwork seems cheesy and “scammy”, but the CANSLIM philosophy is something to definitely learn about if you are interested in individual stocks, as you say you are.

  12. The title is actually pretty catchy. We all know what kind of company Starbucks is. It’s exciting and has good values. I think the name alone is enough to get people to pay attention to this book. Unfortunately, this doesn’t automatically mean the book is going to be a hit with everybody. They would have too high expectations.

  13. Andy says:

    As a kid, I worked in a fast food establishment that had a “fixiins” bar w/tomatoes, lettuce, onions, and condiments for hamburgers. There was one elderly couple that would come into the restaurant, order a sandwich, and use the fixins bar to make a salad. I felt that this was steeling – they were abusing the system.

    One of my wife’s co-workers used to by TVs and computers at Costco, and return them in a year to get an upgrade. He was taking advantage of Costco’s return policy. Recently, Costco changed their policy on these items – returns must be made in 90 days. In my mind this is steeling too.

    To me drinking only water at a coffee shop (or restaurant) is not steeling. Sitting at a table all day, drinking water reading the paper, while paying customers are waiting for a seat may not be steeling, but it is rude. Abusing the system for excessive gain that costs businesses real money is steeling – from paying customers that will be forced to absorb these costs.

  14. Michael says:

    Berkshire is too big to make the big plays that made it big. People watch Buffett closely and drive up prices before he can build a big stake. Also, everyone has access to a decent stock screener these days, so there are fewer cheap stocks available. Also, if Buffett dies the stock price may drop sharply.

  15. Kevin Pickell says:

    Michael,

    Berkshire is not too big. They are compensating by making larger bets. They have much more capital and can now hunt for elephants rather than chickens. Now they often buy entire companies rather than fractional shares. Yes everyone has access to simple screeners these days but that will never put you in a league with Buffett. Buffett has the experience and intelligence to pick up on hidden values and hidden dangers….which a stock screener cannot detect. Screeners should never be used to tell you what to buy and sell. They are merely idea generators. Buffett does not merely buy cheap stocks. Buffett values many intangiables than cannot be digested by numerical stock screens. Regarding Berkshire’s size….let me just suggest that it has been said for years that Exxon Mobil was too large to grow, yet they have continued to grow and produce record profits that are just off the charts. Also…Buffett will most likely retire and enact a succession plan long before his passing, so his demise should have little effect on the company…at least in the long run. Buffett has built Berkshire for the long haul. Many of these companies in their portfolio will continue to be cash machines long into the future….companies such as Geico, Dairy Queen, Fruit of the Loom, NetJets, Benjamin Moore Paints, Iscar, Coca-Cola, American Express, Mid American Energy, Nebraska Furniture Mart, General Re, The Pampered Chef, The Washington Post, Wells Fargo, etc etc. In 2007, Berkshire stock had it’s biggest gain in years and trounced the S&P 500. Buffetts task at succession will be to find someone who can allocate Berkshire’s excess capital at high returns. There are certainly some players out there that are up to the task. Buffett is as good at evaluating people as he is at evaluating businesses. He will find the right person to act as Berkshire’s chief investment officer when the time comes.

  16. Kevin Pickell says:

    Thumbs down on the book. This author has written a nice book that sounds great in theory…but will never work on a practical level. It’s just not that easy, and anyone who has been around the markets for awhile knows this. Did this author happen to publish an audited summary of his own returns using these methods? I’d suggest that Peter Lynch’s books are far more practical(Beating the Street, One Up on Wall Street).

  17. lorax says:

    I don’t buy the premise.

    You get uncompensated non-systematic risk when buying individual stocks. Why can’t the pros do it at least as well as you, thus driving the stock to a fair market value?

  18. Gayle says:

    I have had some success with William O’Neil’s methods as outlined in his books, which are very inexpensive but highly repetitive. His financial newspaper, Investor’s Business Daily is full of information and is the only subscription of any type that I maintain.

    It is not easy to execute, investing in individual stocks requires much more work than most people are willing to put in on a daily basis. If you will not or cannot put in an hour or two every single day you might as well not bother.

    I have found that examining stocks in areas where I already have expertise makes the process much easier. For example, I bought Amgen many years ago because I noticed their products being administered to a certain type of patient. With my knowledge base as a nurse I determined what I thought the potential demand was. The numbers were astronomical and so it proved out. My (now ex)husband and his idiot broker poo poohed the idea. Going with your own specialized knowledge gives you a head start on the rest of the world.

  19. Kevin Pickell says:

    To me it is rather interesting that this blog is about frugality, saving money, buying cheap, getting more for your money, etc etc etc….yet when the conversation turns to investing there is rarely any serious discussions on value investing. It’s like…frugality should apply to all areas of our life except the stock market. There we can speculate and try to find the next Starbucks(wooo hooo!!!) Warren Buffett once said that “you should buy your stocks like you buy your groceries, not your perfume”.

  20. db says:

    I believe (I haven’t tried it) you can buy fractional shares of BRKB through Sharebuilder. Well — I know you can buy fractional shares through Sharebuilder but they have some equities they won’t sell. So my doubt is I don’t know for certain whether BRKB is one of the excluded ones.

    Here’s another frugal thing about BRKB — when you buy it you are essentially getting Warren Buffet as your financial advisor for free. It’s a stock so there is no admin fee like there would be for a mutual fund. And he, Munger and their team of people are still absolutely brilliant about finding value that grows.

    I’m a proud owner of 2 shares of BRKB — as soon as I can I’m buying share no. 3.

  21. db says:

    P.S. — Over the week of Christmas 2007, Berkshire made two HUGE plays. One of them gives Berkshire a huge position in transportation, and the other virtually assures that BRKB will be set to dominate the bond reinsurance marketspace (and be just about the only player without liquidity and credibility issues) for quite some time to come.

  22. Minimum Wage says:

    Berlshire and Google are the new UBIKs.

  23. Kevin Pickell says:

    Yes you can buy Berkshire fractional shares through sharebuilder. I use sharebuilder for my portfolio. If you like Berkshire, then I suggest you also look at Leucadia National(LUK), Markel(MKL), and Sears Holdings(SHLD). LUK has a terrific long term track record and has left the S&P 500 in its dust long ago. I like all of these firms because they are value oriented, shareholder friendly, rational, and have superb management that knows how to allocate capital at high returns. So I always look for good capital allocators…and I have found some of the best with these firms that make up the bulk of my portfolio. These firms are essentially ‘wealth creation’ companies. Joe Steinberg and Ian Cumming manage Leucadia. These guys are as good as Buffett…but know one knows about them. I think over the last 20 years Leucadia has outperformed Berkshire. Not many companies can say they have a better track record than Berkshire for creating shareholder wealth.

  24. Notcho says:

    One observation that I would like to make is about adviser services like The Motley Fool. For a small investor, it’s over priced for the possible returns. A persons returns would have to be huge just to recover the subscription cost. Another factor is the stocks covered in the Hidden Gems section. The vast majority of those stocks aren’t carried by ShareBuilder. You have to deal with ScottTrade or the like. Just my two cents!

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