Imagine if you invested in one of the next great companies while it was still small. Many investors would be thrilled to turn $1,000 into several thousand dollars over a long time, but turning a small investment into a seven-figure sum seems like a feat only a lucky few ever accomplish.
There are plenty of small companies out there that are growing fast and showing the early signs of being a future millionaire-making investment. I looked at many stocks before selecting Home Depot (NYSE: HD) and Southwest Airlines (NYSE: LUV). To be clear, there were several companies I considered that have gone public in the last few decades and are close to turning an initial $1,000 investment into a million bucks.
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However, I chose Home Depot and Southwest Airlines because the amount of growth these companies experienced is staggering considering they didn't offer a breakthrough new product or service to consumers. Instead, these two companies did it the old-fashioned way: by keeping prices low, offering excellent customer service, and filling an unserved need that larger competitors can't touch.
Home Depot opened its first two stores in 1979. The company positioned itself as a store where customers could buy most of the supplies needed to build a whole house. It focused on maintaining a vast selection of inventory that met the needs of do-it-yourselfers and contractors. This strategy allowed Home Depot to fill a niche as a one-stop shop for essential home construction supplies.
At the time of Home Depot's IPO, the economy was doing very poorly, and interest rates were sky-high -- not the best economic situation for a healthy housing market. But as the economy picked up steam in the 1980s, sales and earnings increased exponentially. Management's retail strategy was to maintain a high sales volume and high inventory turnover by keeping prices low -- an approach that worked really well for Walmart in the mass retail channel. Between 1980 and 1984, sales at Home Depot climbed from $22.3 million to $432.8 million as the company opened stores at an aggressive pace.
Home Depot credited its early success to superior selection, competitive prices, and available merchandise, which still contribute to the company's success today. Additionally, Home Depot catered to new homeowners as a place to learn and get advice on home remodeling projects, which fostered a large and growing installed base of potential repeat customers. Today, the company is the world's largest home improvement retailer, with annual sales of $108 billion. A $1,000 investment at the IPO price in 1981 would be worth $13.967 million today with dividends reinvested.
Over the last few years, the airline industry has benefited from lower fuel costs and a better focus on profitability, but for decades, airline stocks were lousy investments. Billionaire Richard Branson, the founder of Virgin Atlantic Airways, once said that the quickest way to become a millionaire was to start as a billionaire and buy an airline. Until the 1970s, the major airlines offered the same service with nothing to differentiate themselves. High costs and a lack of focus on the bottom line led some of the big ones to go bankrupt, such as Delta Air Lines in 2005 and American Airlines in 2011.
However, a small upstart airline in Texas in 1967 became not only the most profitable airline over the last half-century but delivered returns that rival the best-performing stocks in consumer goods or technology. A $1,000 investment in Southwest Airlines at its IPO price in 1971 would be worth $6.1 million today with dividends reinvested.
To understand how a small Texas airline performed so well and why it is still one of the most profitable airlines in the industry today, we first need to look at the circumstances that paved the way for Southwest to commence operations in the first place.
Before the 1970s, no airline company could start flying without approval from the Civil Aeronautics Board (CAB), which was founded in 1938 to keep the major airlines from competing on ticket prices. The CAB regulated the major carriers to compete on quality of service alone. However, the state of Texas was under the jurisdiction of the Texas Aeronautics Commission, not the CAB. After several court battles, Southwest Airlines initiated its service in 1971 to fly short routes between Dallas, Houston, and San Antonio with a single fleet of four Boeing 737s.
Operating outside the CAB's jurisdiction allowed Southwest to lower fares as much as it wanted -- and it did to the point of losing money through 1972. Management's business strategy was to offer exceptional customer service and use low fares and unique marketing to attract customers. By flying short routes, Southwest could keep fuel costs down and also remove the need for other service costs such as in-flight meals. This laid the foundation for revenue per passenger to outgrow costs per passenger. It took a few years to show a profit, but the strategy made Southwest Airlines the most profitable airline in the industry by the end of the 1970s.
The results were extraordinary for an airline operating in a commodity market. The number of passengers carried climbed from 108,554 in 1971 to 759,721 by 1974. As more customers chose Southwest, revenue grew from $2.1 million in 1971 to $14.8 million in 1974. The company was not profitable in the early going, losing over $5 million cumulatively the first two years, but the sharp increase in passengers provided the necessary scale for Southwest to turn its first profit in 1973 of $174,756.
Today, Southwest continues to grow using the same low-cost, low-ticket-price formula and is still adding new routes to drive growth, including long-haul ones -- of course, still flying those Boeing 737s. Its focus on keeping costs down and driving up productivity through frequent flights with one type of aircraft is a strategy that is still working for shareholders. Southwest Airlines reported its 46th consecutive year of profitability in 2018, generating $21.9 billion in revenue and $2.5 billion in net income.
Turning a niche into an empire
There are a few things to remember about the growth stories of Home Depot and Southwest Airlines. Both companies started out serving a specific niche in their respective industries. Home Depot fused the mass retail concept of Sam Walton's Walmart with the home improvement market. Southwest Airlines didn't compete with the major airlines' cross-country routes, but instead filled a profitable niche by flying short routes of less than 500 miles between major cities, and did it with better service and cheap fares.
You don't always have to look for the disruptors to find big winners in the stock market. Sometimes looking for companies that avoid competing with larger rivals by doing one thing extremely well in a specific area of an industry can lead to wealth-building gains over the long term.
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John Ballard has no position in any of the stocks mentioned. The Motley Fool owns shares of and recommends Southwest Airlines. The Motley Fool owns shares of DAL. The Motley Fool recommends Home Depot. The Motley Fool has a disclosure policy.