There’s an expression that goes, “the higher the risk, the higher the reward.” For example, some see risky micro-caps as one of the only ways to reap rapid big gains in a stock.

Well, what if you could get the big reward, without having to take on enormous risk? It’s not easy, but it’s not impossible either.

#-ad_banner-#In fact, in his Top 10 Stocks newsletter, my colleague Dave Forest recently discussed the qualities that he looks for when in search of up-and-coming winners. Dave wrote:

“The qualities that make businesses great inevitably come down to a few basic themes — the kind of check-list items that we can reliably look for in stocks both famous and completely unknown, to determine whether they might suddenly deliver outperformance…”

Dave pointed out six basic themes that, when all are possessed by a company, make it a “must-buy.”

The first step to finding the right company is to focus on firms that aren’t too big or too small.

Obscure startups — with micro-sized market caps — can generate innovative ideas, but often have shaky financials due to their nature as a young business. At the other end of the spectrum, industry giants can offer strong profits and a massive global reach, but are likely slow to grow.

Focusing right in the middle is where you’ll find companies that can generate strong performances and have room to deliver market-beating gains.

This “goldilocks zone” — not too big, not too small — is where I looked to find a potential up-and-coming winner. And after searching, I found a company that looks to have a lot in store for investors in the near future.

Red Hat, Inc. (NYSE: RHT) provides open-source software solutions, storage and cloud technologies to enterprise customers around the world. “Open source” is  software code that is available for modification by anyone.

More than 90% of Fortune Global 500 companies use Red Hat’s products and services.

The company’s primary Linux operating system has been the fastest growing open-source software over the past decade — with Red Hat owning more than 60% of the Linux market.

This growth has led to RHT’s share price soaring nearly 270% over the past ten years.

 

 

 

Those historical gains are impressive, but Red Hat also meets the six “must-buy” qualifications, which puts the company in a position to continue delivering market-beating performance for years to come.

1.Continuing Innovation

RHT was named to Forbes’ list of the “World’s Most Innovative Companies” in 2012 — one of only two technology companies to make the cut.

One of the most innovative aspects of the company is its unique business model: Red Hat gives away its various software programs and charges customers for support services. That has led to a strong degree of loyalty — and high market share.

RHT’s focus on innovation is put on display each year when the company hosts an annual “Innovation Awards” summit recognizing the most creative and determined problem-solving individuals and companies around the world.

2.Heavy Reliance On Research And Development

In 2014, Red Hat spent more than 20% of sales on Research & Development (R&D).

Even more impressive, the company has been consistently increasing its R&D allotment for nine-straight years, with $317 million being spent in 2014.

 

 

Heavy reliance on R&D is a key sign that firms are willing to adapt and stay competitive. Without question, Red Hat is working harder than most to keep ahead of new market developments and changes in technology.

3.Wide Global Reach

Red Hat operates in 85 offices across 35 countries, but the company’s global reach doesn’t stop there.

With its open-source software, RHT has the benefit of thousands of personal users and developers around the world, which helps the company continuously improve its Linux software.

These additional developers helped Linux software surpass Unix as the fastest-growing server operating system in the world.

4.Scalable Products And Services

Sales growth is an important metric to track. Yet it should always be accompanied by profit margin gains. Red Hat’s profits have grown at a slightly faster pace than sales, proving the scalability of its business model.

Year	Revenue	Profits
2010	$748 Million	$87 Million
2011	$909 Million	$107 Million
2012	$1.13 Million	$147 Million
2013	$1.33 Million	$150 Million
2014	$1.54 Million	$178 Million
Avg. 5-Year Growth	19.8%	20.3%

5.Strong Management

An intelligent, hardworking management team is one of the most important attributes of a company poised to beat the market.

Red Hat’s management continues to grow its cash stockpile and has increased shareholder equity an average of 9% in each of the past five years.

And as the company’s product scalbility shows, management’s ability to continue generating increased revenue and strong profit margins indicates a corporate structure determined to build a winning brand.

6.Relatively Unknown Name

With much of its revenue coming from buiness-to-business sales, RHT is not well known to many average consumers, but that bodes well for savvy investors.

The number of unique open-source projects is expected to reach close to 1.8 billion by 2015, according to a recent poll by Black Duck, a private software and consulting firm that releases annual surveys on open-source growth. That’s nearly double where they were in 2013 and almost three times as much as 2011.

As open-source software continues to grow in popularity, Red Hat’s strangle-hold on the Linux market will position the company to benefit greatly.

Currently, RHT sports a price-to-cashflow ratio of 20, well below industry average of nearly 25. This undervaluation makes the company a perfect investment for investors looking to play the future growth in open-source software. 

Risks To Consider: Increased competition in the cloud computing sector from companies such as Amazon.com, Inc. (Nasdaq: AMZN); Google,Inc. (Nasdaq: GOOG); and Microsoft Corp. (Nasdaq: MSFT) could hurt Red Hat’s margins and hinder future growth.

Action To Take –> Investors looking for a company that benefits from innovation, strong management and a 60% share of its market should look to Red Hat. The company’s narrow economic moat and slight undervaluation could deliver further outperformance in the near future.

If you’re looking for the next up-and-coming winner, then check out RHT. But if you’re looking for a proven market-dominator — one that you can buy shares of today and hold forever — you have to read my colleague Dave Forest’s new report “The 10 Stocks to Own For the Rest of Your Life.” In his report, Dave reveals several names and ticker symbols of his favorite “Forever Stocks” and explains how this elite group beat the market by more than 7-to-1 over the last decade. Access his report by clicking here.