In Search of Multibaggers

Most people get excited if their investment doubles. But lately, I’ve been pondering on the topic of multibaggers. I define these as stocks that go triple or more. Is there actually a formula for finding these? Not exactly, but there are some characteristics that they seem to have in common.

Small, Nimble and Growing

There are two excellent books on the topic: “100 Baggers” by Chris Mayer and “100 to 1 in the Stock Market” by Thomas Phelps. Having read these and listened to plenty of Mohnish Pabrai’s interviews, I’ve written a personal checklist on what to look for.

The first checklist item is of course addressing the circle of competence. I need to understand it. We are investors after all, not speculators.

The second thing to check is management. A big part about finding multibaggers is to be right in your evaluation of the leadership. One common aspect of multibaggers is that they are founder led.

Then there’s the question of growth. An owner-operator of a small public company is most likely not short on funds. He or she may be very contented with their life. If their business delivers a great income, do they want to risk investment in future growth? And even if they do, at what pace?

What we’re looking for is an owner-operator with lots of energy and integrity. Someone who really has a vision and destination for their business.

The Quantitative

The qualitative is relatively simple to grasp. Owner-operated ambitious management and a business we understand. But what about the numbers? What we want is high double-digit growth on multiple fronts for prolonged periods of time. Eventually, this should not just lead to a higher intrinsic business value, but the market will place a premium on the growth and thus we benefit from multiple expansion (namely p/e) as well.

In order for us to visualize what is likely to happen to the business and the potential of its runway, we need to have at least some track record. A recently listed company won’t do. Running a public company is very different from a private one, because the obligations are different. The company should have been listed for at least 5 years minimum. But 30 years or more is a bit too old to be looking for a multibagger.

First, the business needs to have consistently high ROE (or ROIC), and growth in its equity value on the balance sheet. 20% ROE or more without it having dipped below this for a long time is a great start. If the company uses leverage, we change ROE to ROIC to include the debt. This leads us neatly to the second point, which is:

Very little to no debt at all.

There’s no need buy companies carrying unnecessary risk.

It’s pretty hard to bankrupt without debt. To quote Peter Lynch, there’s probably some distinguished service award for pulling that off. True multibaggers typically don’t need any of it. If the product or service is outstanding, high value and scalable, adding debt to the equation only increases unnecessary risk. And as shareholders we don’t want that.

It’s All in the Sales

To become a multibagger, a company must have high growth on all fronts. Sales, gross sales, pre-tax sales and earnings. 30% or more is a good number. In order for the company to reinvest the profits, it needs to have more-than-healthy margins. A consistent 40% pre-tax margin is excellent.

Dividends are not necessarily a plus when looking for a multibagger. This may indicate that the company is having a hard time reinvesting profitably. If a business can compound it’s capital internally at high rates, paying a dividend is just foolish. We need to able to visualize the runway, which is why addressing the circle of competence is all important. If you invest on numbers alone, how do you have the conviction to hold for many years? Speaking of which, we need to able to have a perspective of at least 10 years minimum. This is a long enough timeframe for the business to go through multiple cycles and we can evaluate how they handle inevitable difficulties. And see if the story changes.

Multiples Can Be Misleading

The most common multiple people use is p/e. But in our hunt for multibaggers, p/e can be misleading. What we want to look at is the firm’s pretax earnings compared to its market cap. If a company is selling for 100 million, making 40 million pre-tax and growing this at 30% or more each year, it will be making more than its current market cap in less than 4 years. Do you think the company will still be valued at 100 million in 4 years? I doubt it. More than likely, Mr. Market will take notice and the market cap gets pushed upwards. So if all the criteria are met, and you come across a situation like this, why not dip your feet in the water and see what happens in the next couple of years?

A Few Words on 100 Baggers

Yes, they exist. Quite many too throughout the decades. This is evident after reading the two books I mentioned in the beginning. They all had the characteristics listed earlier, but here’s some extra notes:

The median sales of 100 baggers at the start of their journey was $170M. Can be slightly less, slightly more.
They had a market cap of less than $500M.
On average, it takes 17-19 years to reach 100 baggerdom.
10 baggers, on the other hand, had a market cap below $5B to start their journey.

The lack of multibaggerdom in larger businesses is obvious. The law of large numbers prevents excessive growth and an army of analyst coverage will make mispricing highly unlikely.

Happy Hunting!

-IGTSKasimir

Ignore The Street

Intelligent Investing Since 2019