One of the common reasons why many new investors are attracted to the stock market is the lure of high returns. After all, who doesn’t want to get rich fast by investing in a stock that increases your original investment many fold? One of the initial terms used to refer to high-growth stocks was “10-bagger”. This term was coined by the legendary investor Peter Lynch to refer to stocks that had multiplied the investor’s money 10 times the original investment amount.
But as Equity markets round the world continued to grow, we have moved beyond 10-baggers and now we search for 100-baggers. After all, stocks that can grow your money 100 fold are definitely better wealth creators than stocks that grow your money 10 fold. A related term used to refer to such stocks that can multiply your investment is “multibagger” and identifying a multi-bagger stock can help you grow your wealth fast. But how does one identify multibagger stocks?
In this blog, we will discuss the methodology that you can use to searching for and invest in a multibagger stock.
A growing economy like India provides companies with unique growth opportunities. Home grown 100-baggers in India include well known companies and brands like Infosys, Axis Bank, Motherson Sumi, Titan and many more. What’s more, these and other 100-baggers in India do not belong to a single industry or sector, these multibaggers have historically occurred in multiple sectors.
In fact, the broad-based BSE Sensex Index too has been a multibagger. The first time the BSE Sensex reached the a 100-bagger mark was in February 2006 and it has continued to grow since then. As compared to its value at inception, the level of BSE Sensex as of March 2022 would make it a 600-baggerNew Delhi Investment. This means an investment made in the BSE Sensex at inception in 1979 would have grown to 600 times by February 2022. So, the possibility of finding a 100-bagger stock in India is quite real. But the question remains – how do you identify a potential multibagger among the thousands of listed and unlisted stocks in India?
There are currently, 2 key strategies that can be used to identify multibaggers – the concept of twin engines and growth in PE Multiples. Let’s take a closer look at how you can use these strategies to identify multibagger stocks.
The concept of twin engines prominently features in Thomas Phelps’ book titled “100 to 1” and also in Christopher Mayers’ book titled “100 Baggers”. Both of these books provide a roadmap that investors can use to identify stocks that can emerge as potential multibaggers of the future.
The mathematical representation of a Re. 1 investment growing to Rs. 100 would look something like this:
1 * (1+r)^t = 100
Where, r= average annual rate of return in percentage
t= time period of the investmentAhmedabad Investment
So, based this formula, if you stay invested for 30 years, your investment will need to grow at an average annual rate of 16.6% so that a Re. 1 investment grows to Rs. 100.
Similarly, you can also calculate that it will take your investment approximately 41 years to grow 100x if your investment grows at an average annual rate of 12%.
Using this formula you will find that to achieve 100x growth of your investment within 11 years, your investment will have to grow at 50% every year throughout the tenure. Sustaining such high returns over the long term is almost impossible. On the other hand, if you were to assume a more realistic and conservative 15% p.a. return, then it would take 33 years for your investment to grow 100x.
So, if you can identify a high growth stock, you can reach your 100x investment target much faster.
A potentially high-growth stock can typically be identified using 2 parameters:
A company that has consistently grown its revenues, margins, and market share leads the investor’s wealth to grow. This is reflected through a rise in earnings per share (EPS) of the company. The growth in EPS is important as the stock price of the company almost always mirrors the growth in EPS, especially over the long term.
The price/earnings multiple is a key valuation metric considered by investors. The P/E ratio indicates how expensive a stock is, however, when studied over some time, it helps us understand how valuable the company or sector has been to the investors over the years. Hence, a higher P/E multiple indicates that the stock has become a more expensive investment over the years.
Here’s an example of how both these factors can help you detect the prospects of a company. The below table shows the growth of Hindustan Unilever Limited(HUL) over the past 15 years:
From the above data, it is evident that HUL’s share price has grown at a CAGR of 17% over the past 15 years. This does not align with the average growth rate of EPS at 11%. There is an evident 6% gap between the two growth rates. A closer look at the P/E ratio of the company, can help us assess why the the company’s share price has grown at a faster rate compared to its EPS than.
Between 2007-2011, the P/E ratio of the company was in the range of 25-35. But it increased significantly to the 45-55 range during 2012-2017 period. This increase shows that the value of the company increased during the period. What’s more, in recent years, this trend has continued and the P/E ratio of HUL has been in the 65-75 range from 2018 onwardsSimla Wealth Management. This improvement is P/E ratio of a stock over time indicates that the company has added value to the shareholder’s wealth leading to an increase in the price of stocks.
It is important to understand the factors which propel the PE ratio, the growth in PE ratio eventually becomes the guiding force for the growth in stock prices.
Some of the key factors that can impact growth of the P/E ratio include:
1. Growth In Earnings Potential
This is the most common reason for the growth in the P/E ratio of any company. The perceived value of the company goes up when the investor sees growth in the earnings potential of the company.
Achieving operational efficiency has the potential to decrease the overall operating costs of a business leading to an increase in profits. This increase in a company’s profitability through operational efficiencies can also lead to a growth in the company’s P/E ratio.
If a key competitor exits the space, then the market share of the competitor gets divided among the remaining players. If the company under study is well-positioned, then it can see some windfall gains in terms of customers which can translate to increased revenues. This can eventually lead to an increase in the value of the company and a higher P/E ratio.
In some cases, there may be a dearth of investment opportunities in a specific sector or industry. In such situations a company with decent financials and reasonable growth prospects can emerge as viable investment option within the space. This can increase the perceived value of the company’s shares and lead to a rise in the company’s P/E ratio.
Some of the sectors are considered defensive provide a safety factor, they protect the portfolio from severe downturns. FMCG products and pharmaceuticals often continue having sustained demand even during grim market scenarios and this could also act as a stimulus for growth in P/E ratio.
Another reason for high P/E growth is when the company expands into a business with potentially high margins. This can increase the perceived value of the business among investors. For example consider the case of Reliance Industries Limited. The company’s P/E ratio was in the range of 12 to 17 during 2010 to 2016. But, in September 2016, Reliance entered the telecom space armed with a very solid strategy to tackle the competition, its P/E ratio increased dramatically to bring it at par with its key competitor Bharti Airtel, which had a P/E ratio of 40 at the time.
As you can see, Growth in EPS and P/E ratio are two key indicators that a specific stock has the potential to be a multibagger.
As per Thomas Phelps and Christopher Mayer, there are some key characteristics and feature that distinguish a multibagger or 100-bagger from other companies. These include:
Company size can play a key role in determining how fast the investor’s money will growNagpur Investment. Smaller companies usually find it easier to become 100–baggers as compared to larger ones. Essentially, the chances of a company with a market share of 2% achieving supernormal growth are greater than a company that already holds a 30% market share. This is primarily due to the company’s lower base, this when projected on the market capitalisation. This is why we should focus on companies which are valued at less than Rs. 3000 crores when seeking multibagger stocks.
However, this is easier said than done. While there might be many small-sized company with the potential of growing 100x over time, not all small companies will witness sufficient growth. That’s why choosing the right company to invest in is a challenge. As per Christopher Mayer, 100x success does not favor any specific industry. However, investors have a better chance of investing in a multibagger if they to stick to more established companies in stable industries.
Investing in a new company can be quite stressful and the longevity of the business is a consideration for many investors. Even if a company has provided 100x return over the past 30 years, it is not possible to predict that the same company will survive for the next 30 years.
In this context, having a longer runway means the company has more avenues to grow and expand, which in turn translates to a substantial improvement in the company’s earnings per share. This is what Reliance industries have been able to achieve with its entry into the telecom space via Jio. With its entry into the telecom space, the company has opened up other growth avenues like broadband, fibre, satellite telephony, OTT platforms, digitization for MSMEs, Jiomart, a 4G smartphone device, 5G and much more. The company’s entry into these new businesses is expected to help the company survive and grow over the coming decades.
One other valuation metric which indicates a company’s prospects is return on equity (ROE). ROE is when a company reinvests its earnings back into the business which leads to a compounding of returns from the investment. ROE of a company is calculated by dividing Net Income by shareholder’s equity. A high and increasing ROE means that the company is reinvesting its earnings wisely into the business. This can potentially increase profits and shareholder returns from the business over the long run.
Economic moat refers to the existence of a sustainable competitive advantage. There are different types of competitive advantages that a company could possess in the form of intangible assets (patents, IPR etc.,), switching (high cost of switching to a competitive brand), low-cost provider (low-cost provider), toll, network effects, cultural, digital and data advantage. In today’s competitive world, companies need to aim to continually enhance the width of their competitive edge over time. To know more, please read our blog – How to choose investments based on Economic Moats.
The gross margin of a company is the value-add offered by the company’s products and services explained by the extra margin over and above the cost. Mathematically, it is the revenue in excess of the cost of goods sold per unit of revenue generated. One of the best examples of this is Apple which has consistently delivers a gross profit margin of over 35%. Apple has been a 100-bagger many times over and high gross profit margins are a significant metric that can be used to identify 100-bagger stocks.
Historically, owner-operator companies have better odds of reaching a 100-bagger status as compared to agent-manager companies. Companies like Reliance Industries, Wipro, Dr Reddy’s Labs, HCL, Dabur, the many companies within the Tata Group are all examples of owner-operator companies. Current evidence also supports those companies where the owners are involved strategically and are closely aligned to the business objectives. The reasons for success of owner-run businesses include better capital allocation decisions, superior strategic acquisitions, prudent use of leverage, greater focus on cash flow generation, etc. Together these actions increase the chances of a company being a successful multibagger.
The key to achieving 100x on your investment is your investing behaviour. The research conducted by Christopher Mayer concluded that it takes a 100-bagger company an average of 26 years to become one. This essentially means that even if you start investing early you would be in your 40s or 50s when you see your first 100 baggers. Patience or time in market instead of timing the market becomes one of the most important factors for success and there may be times when emotions may run high. It is important to stay rational and stick to your objective. For instance, Apple is the world’s largest company by market capitalization today, but Apple’s ride has been a roller coaster with the stock going through several drawdowns over the past 20 years. Netflix is an even more intense example, with the company losing 25% of its value on a single day in January 2022.
Due to the inherent volatility of stock markets, there are many instances when you may be inclined to sell your investments and cut your losses. But the better option would be to invest in high-quality stocks and hold the investment until it yields the intended returns. So, the success of your 100 bagger strategy will depend a lot on what stocks you invest in and how patiently you can hold on to your investments over the years.
So, the key to making money in stocks rests upon 3 key points: Vision to see the right stocks, Courage to buy the stocks based on your convictions and Patience to hold the stocks till you get the desired returns.
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