Tips For The Smart Investor: How to Spot Multibaggers?

Editor’s comment: Stocks generating a return of more than one-hundred percent are termed as multibaggers. These are undiscovered and undervalued companies with strong fundamentals and a solid management. Such businesses in general have an enduring economic moat or competitive advantage e.g. a proprietary technology or a powerful brand etc., acting as a formidable entry barrier for rivals. With a good capital allocation strategy and a scalable model in place, they present themselves as great investment options.

 

Here are five distinct ways to spot a multibagger stock: 

 

Early entrants in a large growing space: Early entrants in a nascent industry tend to grow as the space grows itself. They quickly emerge as industry leaders (due to lack of competition) and enjoy decent operating margins and a high Return on Equity (ROE) for a decade or two.

Investing in Stock Market: Spotting Multibagger Stocks

For instance, early Indian IT companies Infosys and TCS experienced a high rate of growth in their initial phase of development. This was followed by a consistent above market growth and a high profitability story spanning almost two decades. These companies have also led the way in improving governance and reporting standards, thereby consistently pushing up their valuations.

 

HDFC, Yes Bank, IndusInd were early private players in the Indian banking space and are still growing in double digits while demonstrating consistent profits. This can happen in disorganized sectors as well, where a player comes in, professionalizes and builds a brand. Avanti Feeds is one such success story. A prawn feed manufacturer and exporter of shrimp, the company’s stock price has soared above 400x in the last five years. 

 

Branding Power: With the availability of demand, the marketplace is full of small players competing for a greater chunk of the profits.  But someone comes along, creates a brand and takes away a good share of the profits.  Symphony, the Ahmedabad-based manufacturer of domestic air coolers, industrial air coolers, and water heaters quoted at INR110 ten years back is today priced at around INR1,800, giving a return of c. 16x in 10 years. Page Industries, the licensees of Jockey International and Speedo have yielded c. 80x returns in the last 10 years. VIP Clothing is hoping to repeat the story.

 

Unique Business Model in A New Space: Is a company spotting an unfulfilled need and creating its own space, scaling up, dominating & walking away with the growth & profits. While India doesn't have many of such ventures yet, a pharma or IT product company might as well come up with a world beating product soon. 


Investing in Stock Market: Spotting Multibagger Stocks

Undiscovered and Undervalued Companies: Some companies fail to catch the investor’s attention as the industry isn’t considered attractive enough or fails to resonate with the wider institutional investor community. Due to lower tracking, interest and liquidity – the valuation suffers. Since their business is fundamentally strong, a correction in share price in medium term is likely and hence they become strong contenders for investment.

 

Turnaround Situations: Cyclical businesses i.e. of sectors which are sensitive to economic expansion and contraction, tend to have periodic valuation corrections and timely entry can help investors book the upside. Sugar, metals, pet coke, graphite product companies have seen such a re-rating in the last two years. Sugar had a very short cycle though. In the last three years, numerous sugar companies have generated upward of 20x returns, though are down now as sugar production is in excess again. Jindal Stainless Steel has shown 7x returns over the past two years. Rain Industries has given 10x. The steel & pet coke cycles are still growing. There is still more upside in these sectors. 

Investing in Stock Market: Spotting Multibagger Stocks

A turnaround situation may also emerge when mismanagement, wrong or risky decision-making results in financial distress for a company. Many such cases have surfaced in the recent past, particularly in steel, power and real estate sectors. Public Sector Banks are the latest addition to the list.

 

Companies with strong business models and in spaces which are profitable can be revived through debt restructuring & change of management. This can be witnessed in Jaypee Group, Bhushan Steel, Amtek Auto, and Videocon Industries, where banks are pushing for asset sales and ownership changes to recover their dues. Amongst Public Sector Undertakings, banks such as Bank of Baroda, Vijaya Bank & Indian Bank now offer multiple opportunities. For investors who can take the risk, this space presents some good opportunities.