I am not quite sure of what the term means or where it originated but there is a long and illustrious list of investors who made a fortune by investing in multibagger Stocks. On my part, I have read the investment philosophy of many of those investors to understand how they go about picking stocks. Below I will list certain points which I found consistent, i.e. traits which most successful investors look for.
Key Traits of Multibagger Stocks
At the very start, differentiate between a multibagger Stock and a penny stock. Penny stocks by definition are just that – stocks trading for a few pennies (widely defined as those trading below U.S. $1 in the United States and perhaps below Rs 10 in India). For multibagger stocks, the prime consideration must be the likelihood or potential for growth as opposed to the share price, latter being just a function of the size of the company’s equity base. To take an example, Company X, currently trading at Rs. 300/ share, rises to Rs. 2,100 in 2 years. No matter what you do, do not burn your fingers (and cash) by investing in much hyped penny stocks.
- The company is not very large (Market cap of less than Rs. 200 Cr) – Instead of looking at the share price, look at the market capitalization of the company. Companies with a small market cap are more likely to grow faster compared to those with a big market cap. There are many reasons for why this happens but typically it is because as the business grows, it comes on the radar of bigger institutions and funds. Large fund houses dealing with public money do not look at smaller companies since they tend to be more risky. Once bigger funds start buying the stock, the growth story is factored in.
I believe there is another reason why smaller companies multiply faster. When a business does well, it is natural for the management / promoters to diversify not just their markets and products but also their cash. They start investing in ideas and products that offer a high level of safety. This complacency runs parallel to the “high risk high reward” principle of business. That is why the ‘phenomenal growth phase’ for most successful businesses happens only once in their lifecycle.
- Product or idea is in a field that is likely to grow – This is the heart of any fundamental research and not just when looking for multibaggers. The success or failure of any investment depends upon future growth of the underlying product or service. Future outlook and foresight in this regard is often about the ability to spot opportunities and trends and not so much about the strength of the financial statements of the company.
Consider this scenario – Watsapp or Facebook or any other technology company using internet service comes up with a solution which enables free voice calls between smart phones. Is it then possible that the entire telecom sector gets destroyed? What will happen to Vodafone, R-Com, Airtel, Idea? What is the likelihood of free calls on phone in the next few years? This thought may ring alarm bells if you are invested in telecom. At the same time supporters of this sector will argue that these companies will start earning higher revenue by providing faster internet services which in turn will form the backbone of any value added service like free calls.
- Pure Play – The product or service that gets you excited should be all or nearly all that the company makes. I support pure plays even when the company grows to the size of a mega cap. To that extent I do not support how ITC has organized its business but again, ITC has reasons to diversify. A young startup diversifying into many business verticals is sure sign, either of confusion or of abandonment of core business. Look for companies that are focused on creating and improving what they started with.
Diversification – the art of screwing up many things at the same time
My favorite pure play example is Asian Paints. The company has a market capitalization of over 60,000 Cr. and the only thing they have ever done is making paints.
- No Hype – Look for companies that are not covered by most fund houses, i.e. the market should not be conditioned or excited about the stock. Again there are 2 things here. First, sometimes even the smallest companies or penny stocks become really hyped and everyone seems to talk about them – as an example search for Cals refineries (it’s a stock not to own). Mostly, such stocks are being propped up or are being managed by operators. Avoid them!
Second, you are far more likely to find value in companies that are ignored by the large fund houses. Why do large fund houses ignore many such companies?
Mostly because there risk management policies do not allow them to look for companies below a certain market capitalization. It is here that the potential to discover hidden value stocks exists more than anywhere else.
- Economic Moats – Economic moats are not just relevant when looking for well established large cap stocks. Often smaller companies have the strength of such moats. Focus on Product patents or monopoly (or near monopoly) rights. There are certain sectors where you will see even the smallest companies getting patents for their invention for example – pharmaceuticals. If you can spot a young company which already has a patent for its invention, and you manage to do it before the whole world does – just grab it right there.
Finally, these points mentioned above will be helpful only in the initial discovery of companies. A good analyst must do a full analysis thereafter. In particular, look for promoters holding and find out more about the background of the promoters and that of the management team.
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For a list of companies we are currently interested in, in the multibagger /small cap space, you should visit the premium member section of our website.
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