1. What is a multibagger stock? Here’s how to identify one

What is a multibagger stock? Here’s how to identify one

Any stock that generates more than 1000% return over a period of 5-10 years can be termed a multibagger

By: | Updated: December 6, 2016 3:11 PM

MULTIBAGGERS is a term that we often hear of. Though there is no specific definition available for this term, researchers agree that any stock that generates more than ten-fold (1000%) return over a period of five to 10 years is a multibagger. Let us see how a multibagger in the making can be identified:

Identify a suitable firm

Investors can identify a suitable company by looking at the industries which are witnessing high growth. The industry should be new, or belong to a niche area or be experiencing a disruptive innovation which will benefit all companies in the category. This industry should have a promising, expanding and great market opportunity. Then identify a suitable company within that industry and buy its shares before there is widespread recognition of its potential.

Buying at the right time

Having identified the industry and company that you envisage as a multibagger, it is not necessary to buy the shares immediately. Buying shares of a good company at the right price will result in a multibagger. One way is to buy the shares at a low extrinsic value which normally generates very high returns. Though there are different methods of valuation available, one should choose the appropriate one. For instance, price earnings (P/E) ratio holds true only for businesses with very predictable cash flows and a definite terminal value.

Higher sales to fixed assets

Those companies where revenue generation is higher than that of fixed assets have a better chance for higher valuation in the market. Such businesses may have higher fixed assets initially. However, later they generate revenue without requiring any further installation. One way to capture this phenomenon is to observe the fixed assets turnover ratio over a period of time.

Identify earning and scalability

Instead of simply looking at the earning figures, look for the sources of earnings of the company. If you see that the potential to grow the business is significant in the segment where the company is operating, then it is a good idea to buy its shares. Don’t focus too much on whether the share is a large cap, mid cap, small cap or micro-cap. Instead, look at the scalability of the operations.

Focus on gross margin

Gross margin is a good indicator of how a firm has great control over its cost of goods/services/extraordinary specialisation or reputation. Generally, companies with higher gross margins are potential multibaggers. Customers of such firms find value in their products and when these products reach broader markets, the potential becomes tremendous.

Look for cues of capex

One should read and understand the quarterly presentations uploaded by firms on their websites. Here, information related to capital expenditure, structural changes in the company, other key management decisions, is provided. When the company’s capital expenditure (capex) increases, it is a sign that it is expanding its capacity or replacing its existing plant and machinery, etc.

Multibaggers are not for everybody. While some exposure to potential multibaggers can add to the returns on the average portfolio, one should also keep in mind cash flow needs, risk tolerance and volatility to capture these returns.

The writer is associate professor of finance & accounting, IIM Shillong

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  1. R
    raju
    Dec 6, 2016 at 4:32 am
    I have only heard about multibagger. It is an interesting article to understand the same.
    Reply

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