While there are no guarantees in the stock markets, stocks that went on to become multibaggers had many traits in common. Let’s see what they are.
In the world of stock investing, there is a word used for stocks that have blessed their investors with returns multiple times higher than the price they were bought for. Such stocks are known as multibagger stocks. Coined by ace investor Peter Lynch, investors who identified them correctly and remained invested for the long haul saw their wealth grow exponentially over the years. So, how do we know if a certain stock will become a multibagger? While there are no guarantees in the stock markets, stocks that went on to become multibaggers had many traits in common. Let’s see what they are:
A sustainable business is backed by a capable managing board and ethical corporate governance. You may have seen how the price of a stock plummets when a key senior leader quits abruptly or when the company lands into regulatory trouble with governing bodies. This is proof that investors base a lot of trust in the abilities of senior leaders to drive business growth while maintaining stakeholder harmony.
While looking for a multibagger, take a look at top management team, their experience and credentials, check whether there has been hasty exits of key personnel . Apart from this, also look for any defaults the company has done on the regulatory front, see if there have been disputes with workers or vendors or other key stakeholders. Another important thing is to see how swift the company’s management has been in clarifying the exits or defaults and how fast has the company bounced back from set-backs. Any lapse here after a reasonable period of time is a red flag to watch out for.
Strong Economic Moat
With such fierce competition in the market, only companies that are on their toes when it comes to innovation will remain in business. A multibagger always scores over other peers offering the same value propositions. The company differentiates itself in terms of customer obsession, better quality of service/products at a lower price band, and a wide product suite. Companies that evolved to become multibaggers were usually pioneers in the field who ventured into areas others were afraid for. They possessed the foresight to spot opportunities and hence enjoyed the first mover advantage. The constant diversification in offerings and innovation in pricing further cemented their position. To spot whether a company possesses an economic moat or competitive advantage, look at their research and development capabilities, how frequently they launch innovative products, how innovative they are with their pricing and the demographic variety they cater to.
Strong Promoter Holding
Multibaggers have strong promoter holdings. A strong promoter holding or a rise in the same shows a strong belief by the founders in the business. Promoters buying more shares of the company show that they are aware of the potential of the business and want to benefit from it. Needless to say this has a positive impact on investor sentiments too. On the other news about promoters making a hasty exit and relinquishing their shares does not sit well with investors and impacts their belief. You can look at BSE and NSE websites to see the promoter holding for listed companies. Analyse the holding pattern of promoters for the available shares. Also, take a look at how the holding is pledged, whether it has been maintained over several quarters or not. If you see the promoter has pledged a part of the holdings for loans, then it may indicate that the company is not doing well financially, which is something to pay heed to.
Good Growth In Earnings
Due to a lucrative growth, profitability model capital allocation model, a multibagger will typically have high growth in earnings. It is an important factor to look for since the actual earnings of the investor is nothing but the earnings or profits after tax. If the earnings per share is increasing, it is a good indicator that the company has good growth potential. 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.
The Business Has A High Margin
This can be thought of as a byproduct of economic moat; multibaggers command a high margin. These margins are sustained or increase over a period of time in case of multibaggers and is not a one-off case. Needless to say the sustained profitability has a key role in the making of a multibagger.
Judicious Capital Allocation
Multibagger companies are highly sustainable. Due to the economic moat and consequently the high margin, these companies are able to generate free cash flow internally which is used for business expansion or paying dividends. Needless to say they have little to no debt and have lower debt level against equity.
You can look at the characteristics mentioned above as a starting point to identifying multibaggers. The important thing to see here is that companies did not become multibaggers overnight. 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 thorough in your research about the company, analyse the fundamentals, and give at least 5-10 years to a growing business to show its true potential.
(By Harsh Jain, Co-founder and COO, Groww)