In my last column, I talked about mastering the art of intelligent speculation.

One method is to follow a select group of speculative stocks with the potential to rise tenfold or more.

Here are six characteristics that we’ve found ten-baggers typically have in common…

1. They are tremendous innovators.

Companies that rise tenfold or more offer revolutionary technologies, new medical devices, blockbuster drugs, and other state-of-the-art products and services. Over the last 10 years, for instance, investors have been stunned by the moves up in Tesla (Nasdaq: TSLA), with its electric cars; Apple (Nasdaq: AAPL), with its cutting-edge electronics; and Amazon (Nasdaq: AMZN), with its breakthrough e-commerce platform and one-click ordering system.

2. They experience terrific sales growth.

Notice I said sales growth, not profit growth. A lot of the best-performing companies were not profitable in the early stages of their run-ups. But even if they were losing money, they usually experienced top-line growth of 30% or more.

3. They protect their margins.

Huge sales numbers attract competition the way honey attracts bears. That means a firm has to be able to protect its innovations with patents, brands and trademarks. Otherwise, competitors will flock to the industry, grab market share and force down margins.

4. They beat consensus estimates.

Profit growth is what drives share prices higher. But in the short term, it’s all about beating expectations. Even if a company loses money – if the loss is smaller than expected – it can register as a significant beat.

5. They are small cap to midcap companies.

The best-performing stocks of the last few decades started out as small companies. And over the last century, small caps have outperformed large caps by more than 20% annually. Huge companies simply can’t grow at the breakneck pace of smaller ones.

6. They are relatively unknown.

The less people understand about what a company is doing – and the less media and Wall Street coverage it gets – the better the chance that its shares are mispriced. Hot stocks with splashy stories have not been the best performers, historically. By the time a company becomes widely known, much of its parabolic move upward may well be over.

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Our Ten-Bagger recommendations are qualitatively different from the other companies we recommend. They are smaller, sometimes unprofitable and almost always more volatile.

This requires us to use a different sell discipline.

We don’t use our customary 25% trailing stop with the Ten-Baggers of Tomorrow Portfolio.

Instead, a sell recommendation is triggered if a company misses the quarterly consensus sales estimate by 20% or more – or if we believe the company’s business prospects have changed for the worse in some fundamental way.

These stocks are meant to be held longer term. They will bounce around more than most. (In technical terms, they have a higher beta.)

And our exit is ultimately based not on share price fluctuations but on how the company’s net compares with expectations.

How has this strategy worked in practice?

Very well. In 2017, the first full year for the portfolio, it returned 27.6%. The S&P 500 returned 21.6%.

As is typically the case, the vast majority of professional fund managers underperformed the S&P last year.

As you can see, intelligent speculation is not a contradiction in terms. You can enjoy higher-than-average returns without taking a boatload of risk.

Our Ten-Bagger strategy is not the only way to do it. But it’s one of the best ways I’ve found.

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Good investing,

Alex