Published: February 17, 2010

Every company has a life cycle. Some, like Microsoft (Nasdaq: MSFT) or Google (Nasdaq: GOOG), seemingly come out of nowhere to dominate their industries. Others, like Consolidated Edison (NYSE: ED) or General Electric (NYSE: GE), have delivered steady returns to shareholders for decades.

But let's face it: as far as outsized gains go, Microsoft has had its day. The law of large numbers makes it unlikely the shares will deliver another +36,000% any time soon. Similarly, Google may continue to reward its shareholders, but its growth-spurt is in all likelihood history. So who's next? Which companies are poised to deliver gains in the triple digits… or more?

Newly-formed businesses generally have just begun to realize their market potential. Successful companies usually produce their strongest growth in the early years of their life cycle.

An initial public offering (IPO) is an effective way for a business to raise capital and fuel growth. A company undertaking an IPO is essentially selling itself to the public in hopes that investors will recognize the company's potential to deliver earnings and growth.

Young firms tend to see their most dramatic revenue and earnings growth within the first five years of a public offering. So, it stands to reason that companies that have recently gone public would be a good place to look for high growth.

The problem, though, is that IPOs have been in short supply lately. Activity has picked up from when I first wrote about IPOs in October 2009, but we're a long way away from the heady days of the 1990s.


Companies are often hesitant to go public in an uncertain market. Most investors are leary of picking up the shares, too. Market data show, however, that IPOs have an uncanny history of outperforming the market leading out of a downturn. According to The Wall Street Journal, IPOs outperformed the market by +10.5% during the three years after the 1987 crash. The same thing happened after the dot-com bubble burst: IPOs beat the market by +13.1% in 2001 and by +38.9% in 2002.

This outperformance can largely be attributed to the fact that only the most resilient companies with promising futures have the confidence to go public in a downturn. Less stable companies might choose to wait it out instead.

Obviously, none of this means investors should simply buy every IPO that hits The Street. The market has been filled with plenty of IPOs that never lived up to expectations. Besides, it can be difficult for individual investors to nab a company's initial offering price. Most IPOs are controlled by institutional investors. But you don't have to get in on day one; in fact, it's often preferable to see how things shake out after the initial wave of enthusiasm ebbs.

I recently asked the StreetAuthority research team to hunt through piles of data in search of companies that met the following conditions:

-- Stocks available in the United States
-- IPO date after the market crash (Sept. 2008)
-- Market capitalization greater than $100 million
-- Operating margins greater than 30%

Operating margins measure how efficiently a company converts sales into profits. By focusing on operating profit rather than total profit, we eliminate the effects of extraordinary items unrelated to a company's main business that can obscure its true profitability picture.

The key here is to look for recent IPOs that are showing signs of both strong growth and profitability. Some of the companies in our results would have only recently gone public and would not have a string of public filings to demonstrate these measures. Also, some would be young and unprofitable. So, to narrow our focus, we'll also only consider:

-- Profitable companies with positive earnings in the most recent quarterly filing (at least)
-- Positive quarter-over-quarter revenue growth

After pouring over the results, here's what we found:

My favorite pick from this list is Duoyuan Water (NYSE: DGW), a Chinese water sanitation, treatment and purification company.

The Chinese government faces a major challenge in providing its growing population with enough potable water. Duoyan's main growth driver is the shortage of clean drinking water and wastewater treatment in China. The country has large amounts of fresh water, but more than 60% of it is too polluted to drink. Only about one-third of waste water is currently treated.

China's 2008 stimulus plan included more than $50 billion for wastewater and solid waste treatment. The government is also tightening standards for safe drinking water. As China's population grows and citizens grow increasingly affluent, demand will only increase further. The government will need Duoyan's services to meet this need.

By the way, I'm not the only one excited about important water stocks: Government-Driven Investing expert Andy Obermueller just wrote a report about a revolutionary water company (NOT Duoyuan Water) that could literally save the world and deliver a +257% gain by the end of 2010. You can view his report here.

Another alternative is the First Trust U.S. IPO Index Fund (NYSE: FPX). FPX is an exchange-traded fund, and it offers the best way for individuals to get in on the ground floor of IPOs without having to buy shares individually.

Editor's Note: "Inside the Numbers" is a periodic feature that will use our screening methods to develop a list of investment opportunities that might be worth examining further.

-- Brad Briggs
Staff Writer
Street Authority