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How To Best Spot Multibagger Stocks: All You Need to Know

Investing; Blogging,
Dec 1, 2017 1:23 PM 6 min read

I recently read the book 100 Baggers: Stocks That Return 100-To-1 and How to Find Them by Christopher Mayer. Here’s a quick summary for the benefit of fellow investors. Hopefully, this will cover all you need to know to position yourself ideally for any potential multibagger stock investment oppurtunity that may come by. 


The three basic questions for every investor who wants to spot multibagger stocks are: WHAT to buy? WHEN to buy? HOW to hold/sell?


Simple steps to have 100 Bagger Stocks in the portfolio:


  • Find great business at a reasonable valuation
  • Hold them for a long period of time

According to Thomas Phelps's 100 to 1 in the Stock Market, to make money from stocks, one must have:


"The vision to see them, the courage to buy them and the patience to hold them."


Key areas to focus while identifying great businesses that can potentially turn into 100 Baggers (based on patterns identified from prior 100 Baggers):


  • The business should provide a solution
  • It must have an enduring moat or competitive advantage
  • Excellent capital allocation strategy
  • Long runway
  • Earnings Power
  • Ability to re-invest capital at a high return on capital
  • Company should be run by owner-operators with skin in the game

What to watch out for: 


"Every human problem is an investment opportunity if you can anticipate the solution". 

Companies which have new methods, new materials and new products; essentially things that can improve one's life, solve problems and allow us to do things faster, cheaper, and better.


Study markets and invest in long-term enterprises with the potential to vastly outpace other companies and industries. Stick with them for as long as the theme is intact. 


Intuitive formula for 100 Bagger Stocks:


Earnings Growth + PE Re-rating = Multi-Bagger


Key factors for Earnings Growth:


  1.  Sales Growth: Sales Growth in general comes from gaining market share in the existing markets, expanding into new markets and creating new products
  2. Operating Leverage: Operating Leverage comes into play when businesses have a high fixed cost giving them economies of scale, advantages of a network effect and bargaining power to bring down costs
  3. Margin Expansion: Margin Expansion happens from reduced cost, improved efficiency, pricing power and sticky products
  4. Debt Reduction: Debt reduction due to cash flow generation reduces finance cost and further improves earnings


The fastest Multi-Bagger returns are achieved from a combination of the above factors. 


Thus, the single most important factor is GROWTH in all the dimensions - sales, margin and valuation.


Market leadership can directly translate into higher revenue, higher profitability, greater capital velocity and correspondingly stronger returns on invested capital.


Identifying great businesses with enduring moat:


"A truly great business must have an enduring "moat" that protects excellent returns on invested capital" - Warren Buffett


In his The Little Book That Builds Wealth, Dorsey uses an analogy for why you should pay attention to moats: “It’s common sense to pay more for something that is more durable. From kitchen appliances to cars to houses, items that last longer are typically able to command higher prices...The same concept applies in the stock market.”


Some very common forms of Moats are:


  • Strong Brand
  • High switching cost
  • Network effects
  • Low cost advantage
  • Economies of Scale
  • Patents and IP

Moats, in essence, are a way for companies to fight mean-reversion, which is like a strong current in markets that pulls everything toward the average.


Michael Mauboussin has done some good work on Measuring the Moat. He suggested interesting a mental model to find a Moat in the sector value chain using an industry map.


This details all the players that touch an industry. For airlines this would include aircraft lessors (such as Air Lease), manufacturers (Boeing), parts suppliers (B/E Aerospace) and more. What he aims to do is show where the profit in an industry winds up. These profit pools can guide you as to where you may focus your energies. For example, aircraft lessors make good returns; travel agents and freight forwarders make even-better returns.


Some indicators of companies in the value-chain having Moats:


  • Track record to earn a high return on invested capital
  • High gross and operating margins for a long period of time

Gross margin is a good indication of the price that people are willing to pay, relative to the input costs required to provide the goods. It is a measure of value addition for the customer.

Earnings Power and not Earnings:


One common trap is that earnings has many limitations. One has to also look for long terms earnings which can be produced by intangible growth-producing initiatives such as R&D, promotions/advertising and employee education. Though these are expensed, their benefits come in for the long-term.


Earnings power reflects the ability of the stock to earn above-average rates of return on capital at above-average growth rates. It is essentially a longer-term assessment of competitive strengths. 


A company can report a fall in earnings, but its longer-term earnings power could be unaffected. In the same way, earnings may rise but the underlying earnings power may be weakening.


Capital allocation:


Saurabh Mukherjea talks about many Indian businesses which turned into Multi-Baggers in his book "The Unusual Billionares". Efficient Capital Allocation is one of the most common and important characteristics of all great businesses.


Promoters/CEOs have five basic options to allocate capital:

  1.  Invest in existing operations
  2. Acquire other businesses
  3. Pay dividends
  4. Pay down debt
  5. Buyback stock


There are three basic ways to raise money:

  1. Issue stock
  2. Issue debt
  3. Use the cash flow of the business


This forms the collective toolkit for any capital allocation decision which if used wisely can generate excellent results for the company.


  • Capital allocation is the CEOs most important job
  • Value per share is what counts, not the overall size or growth
  • Cash flow, not earnings, determines the value 


Long run-way:


We need to understand that the value of a business is the sum of its future cash flows, discounted back to the present. Hence, focusing on long run-way of business unaffected by disruption (or ones which can evolve) and having a long-term view is extremely important.


Return on Capital:


This is one of the most important parameter. If a company can continue to reinvest at high rates of return over long periods of time, the stock and earnings keep compounding giving a parabolic effect.


"If a business earns 18% on capital over 20 or 30 years, even if you pay an expensive looking price, you'll end up with a fine result" - Charlie Munger

Company run by Owner-Operators:


Owner-Operators have their skin in the game, and an efficient capital allocation by the owner can create miracles for the company. 


Source: Horizon Kinetics


Also, it is easier to hold onto a stock through the rough patches knowing that we have a talented owner-operator with skin in the game at the helm.


Holding great business for long period of time requires investors to build resilient psychology


Boredom Arbitrage - having truly long term view of business:


Investors crave activity and stock markets are built on it. The media feeds it all, making it seem as if important things happen every day. This results in churning of the portfolio in a very short time period. 


The ecosystem doesn't want you to sit tight, they want to charge you fees, brokerage and sell you stuff. The greatest fortunes however come from gritting your teeth and holding on.


Most investors have been conditioned to measure stock price performance based on quarterly earnings but not on business performance. Investors can think in terms of years and invest in stock which is cheap today because others can't look beyond a few quarters.


One can benefit from boredom arbitrage since people get bored holding the same stock for a long time - especially if it doesn't do much.


Once we identify great businesses which can compound over a long period of time, then the only task that is left is to SIT TIGHT. It sometimes takes more than 3,5 or even 10 years to get 100-fold returns. And holding onto stocks beyond that period requires PATIENCE.


Roller coaster investing while holding:


As professor Sanjay Bakshi has put out very clearly in his article "Roller Coaster Investing" that holding great businesses for very long period of time involves tough times. One needs to develop the ability to stomach the ups and downs and hold on.


For example, Netflix fell 25% in single day for four times since 2002 and there was a 4-month stretch when it dropped 80% but it became 60-bagger since 2002!! Apple had a peak-to-trough loss of 80% twice!!


As Philip Fisher puts in his book Common Stock and Uncommon Profits


"If the job has been correctly done when a common stock is purchased, the time to sell it is — almost never.”  


This is the path to true wealth creation through stock market investing..!!


Originally Published on TECHNO FUNDA 

Source: Horizon Kinetics