What Smart Investors Use to Spot Explosive Stocks Before Wall Street Notices

Want to spot the next Amazon (NASDAQ: AMZN), Nvidia (NASDAQ: NVDA), or Coca-Cola (NYSE: KO)?

These stocks have minted fortunes for investors who had invested early on, showing off the true miracle compound earnings can achieve for one's long-term financial independence.

The rub is that while these long-term winners seem obvious in retrospect, not many investors knew early on that these stocks would grow into the 100-baggers they eventually became.

Yet while each of these prior cases is slightly different, all have three main things in common. If you find an under-the-radar stock with these attributes today, you have pretty good odds of buying the next big thing.

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1. A sustainable competitive advantage (in the building stage)

Outsized stock performance comes from outsized earnings growth over the long-term, and especially outsized earnings growth that comes at a high return on invested capital.

High ROIC and earnings growth generally mean a company has some sort of extraordinary advantage over competitors, or has built a business so formidable that new competitors won't even try to compete.

Once a formidable economic moat is built and earnings take off, many investors tend to notice. But if a savvy investor can see an emerging moat as it's being built, and invests before the market catches on, that could be a recipe for massive long-term gains.

Some examples from the past include Nvidia (NASDAQ: NVDA) building up its CUDA software stack, which enabled its graphics chips to be used for parallel processing for big data and artificial intelligence applications.

Nvidia began building CUDA in 2006, and while the company achieved some AI success in the following years, the advent of generative AI and ChatGPT in 2022 caused Nvidia's sales to take off. But if an investor had identified this CUDA software moat early on and held Nvidia for the long-term, you would have made a tremendous amount of money.

Another example is Amazon (NASDAQ: AMZN). As an early leader in e-commerce, Amazon traditionally eschewed near-term profits to continue investing in its massive distribution and fulfillment network. The investment in its delivery network and expanding assortment of items took tremendous investment over many years. But flash forward to today, and Amazon's ability to deliver items within one or two days is unmatched. If anyone attempted to compete by building a similar network, it would similarly take that amount of money to build. That has thus far deterred many serious competitors.

The concept is similar to Warren Buffett's take on his Coca-Cola (NYSE: KO) investment, which was a tremendous outperformer in the latter part of the 20^th century. Buffett had long admired Coke's brand power, once elaborating that, "If you gave me $100 billion and said, 'Take away the soft-drink leadership of Coca-Cola in the world,' I'd give it back to you and say it can't be done."

Long-term winners with competitive advantages tend to take more market share and/or garner significant profits relative to the also-rans. So, identifying a company building a strong moat of some kind is essential.

2. A large addressable market

Competitively advantaged companies do tend to outperform over time, but truly explosive winners like Nvidia, Amazon, or Coca-Cola need a second ingredient: a huge total addressable market.

In Nvidia's case, CEO Jensen Huang anticipated a shift in computing, from traditional CPU-based computing to GPU-based acceleration for AI. In this case, the addressable market was basically the entire world of enterprise computing, which is massive. Huang noted the installed base of data centers at the launch of ChatGPT was around $1 trillion.

That's a huge market in and of itself, but Huang also noted that AI's usefulness should take that investment to $2 trillion soon and perhaps $3 to $4 trillion by the 2030s.

Similarly, Amazon invested not with an eye toward next year's profits, but an eye for e-commerce to take over much of the retail space globally. That bet has worked out well; according to Grand View Research, the global e-commerce market topped $5.8 trillion in 2023, with an expected 11.6% growth rate through 2030.

That stellar rate for such a large market is due to e-commerce taking more and more share from traditional retail, which amounted to $32.6 trillion globally last year, according to Vantage Market Research.

And of course, Warren Buffett was famous for timing his Coca-Cola investment just as the company was expanding from the U.S. into global markets. The move to expand internationally greatly increased Coca-Cola's total addressable market in subsequent years, fueling newfound growth for the company and leading to Buffett's huge gains in the stock.

3. A visionary CEO and management

This attribute is tied to the other two attributes, since it's logical that any management team worth its salt would go about seeking large markets and building strong competitive advantages. Still, running businesses is not easy, and building moats and expanding into new markets requires skill and prudent capital allocation.

That's why a leader like Jeff Bezos at Amazon was so important. How can one identify these top CEOs? First, many tend to be founders. In addition, many founder-CEOs aren't shy about disclosing their business philosophy. Jeff Bezos, for instance, would attach his 1997 letter to shareholders below every subsequent letter, in which he outlined Amazon's core principles of customer obsession, investment to seize large opportunities ahead, and a long-term focus on building leadership moats.

Jensen Huang also wasn't shy about discussing CUDA software back in the 2000s when it was first being developed. Similarly, Warren Buffett roundly praised CEO Roberto Goizueta at Coca-Cola, who became CEO in the early eighties and helmed the strategy for aggressive international expansion, as a big reason for his decision to invest.

The lesson is that business strategies and moats don't happen on their own -- they are built, and need to be nurtured. Furthermore, expansion beyond a core market, such as Amazon into cloud computing or Coke into international markets, can be difficult and require strong business leadership to get results. That's why a focus on this third qualitative measure shouldn't be overlooked, along with an emerging moat and large market opportunity.

Now that you know the three main ingredients for massive market leadership, start hunting for small and mid-cap stocks with these attributes. It may just become the next 100-bagger!

Billy Duberstein and/or his clients have positions in Amazon. The Motley Fool has positions in and recommends Amazon and Nvidia. The Motley Fool has a disclosure policy.