When it comes to stock investing, there is a common word used for stocks that have given returns multiple times higher than their associated cost of acquisition. These are called multibagger stocks. These stocks were first invented by Peter Lynch; published in his book, One Up on Wall Street. Fortunately, these winner stocks tend to have unique characteristics that differentiate them from the rest. In this article, I will cover how to identify multibagger stocks and reap the benefits of their wealth creation potential. Read on:
Strong and capable management
The sustained growth and success of a business is a direct derivative of the capable management team that backs it. Without able administration and strategists that drive growth, a business wouldn’t be able to compete with peers. While looking for a multibagger, look at how strong corporate governance is. Keep an eye on the governance practices, how independent the board is, whether the funds are being used for the growth of the business or if they are being diverted to other businesses or for personal interest, pledging of shares, adherence to regulatory obligations and able stakeholder management. This will give you an idea about the ethos of the business and whether they have uncompromisable standards. Any defaults here should definitely be taken seriously and is a serious red flag to watch out for.
The competition in the market is fierce and only constant innovation will pave the way for continued success of a business. A multibagger always scores over peers offering the same value propositions. It does so by showing high customer centricity, offering better quality services at a lower price, expanding their product/services suite and constantly evolving with the times. In fact businesses that have shown phenomenal growth over the years were usually pioneers in their fields, spotting opportunities way ahead of their contemporaries and then quickly acquiring the first-mover advantage. To spot whether a company possesses a competitive advantage, see how innovative they have been. You can do so by taking a look at the patents they have, how active their R&D wing is and how frequently they launch innovative products and services, what their pricing strategy is, etc.
Strong promoter holding
Investing in a business also means sharing belief in the potential of the business with the people who started it. A sign of a multibagger is when the management is very vocal about their vision for the company and the strategy to achieve the same. If the founders or early members of the organisation are seen defaulting on certain occasions, exiting the company in haste and relinquishing their own shares then there isn’t much to evaluate here. Needless to say, substantial promoter shareholding is an essential factor to take heed of while assessing a name.
Healthy growth in earnings
A multi-bagger would typically have high growth in its earnings due to its revenue growth model, profitability model, and also capital allocation model. What a shareholder earns is nothing but the earnings (or the profit after tax), so it is an important indicator to look at while searching for a multibagger. A growing earnings per share will give you a fair idea about the growth potential of a business. You can use the formula given below to estimate the same. EPS= Net Profit/ Number of outstanding shares. The EPS shows how much a company is earning against each share.
High margin business
Another common characteristic which is a result of having a competitive advantage is that multi-baggers command a high margin. An important thing to note here is that this is not a one-off case and these margins are usually sustained with little to no fluctuations. Needless to say the sustained profitability has a key role in the making of a multibagger.
Prudent capital allocation
Multibagger companies are self-sustained. Because they are profitable and have a high margin, they use internal funds to expand their product suite. Consequently, they function on little to no debt and have lower debt level against equity. They are able to generate free cash flow (computed as cash flow from operations minus purchase of fixed assets) for a long period of time which is either used to pay dividends or reinvested for growth and expansion.
What investors should do
While it's easy to identify a multibagger, the real benefit is seen only when you remain invested in them for a long time. All the businesses that went on to become huge successes started slow and were built over time. Investors who believed in the growth potential of the business and remained invested without focussing on market ups and downs were ultimately rewarded in the form of huge profits. So be deliberate in your research while assessing a business for its fundamentals and then be patient enough to allow your investments to give results. Eventually, your steadfastness will be rewarded and you will be able to ride on the success of these multi-baggers
Harsh Jain is COO and Co-founder of Groww.
First Published: IST