How to Identify Multibaggers in the Stock Market?

Making a large sum of money out of a minimal sum is a dream for many investors. What if someone told you that you could make multiple folds of money in a few years just by investing in the right companies at the present day?

Peter Lynch coined the term in his 1988 bestseller “One up on Wall Street”. He borrowed the idea of a multibagger from the world of baseball, where “bags” that a runner reaches are the measure of the success of the play. These are stocks that can generate multiple bags of money over the next few years and have the potential for explosive growth over time. A stock like Bajaj Finance is up by a massive 100 times between 2010 and 2020. Its price as of 1 Jan 2020 was Rs. 4232 and traded at Rs. 34 on 1 Jan 2010.

These stocks evolve gradually; they would not promise you immediate returns, but with good management and a right strategy they can turn into multibaggers over time.

Is spotting multibaggers a game of blind speculation, or is there a method behind the madness?

Doing proper research and having a fair idea of what drives stocks can be of great use in order to identify multibagger stocks. Investing in multibaggers can be looked as investing in solid business models and good management at the start of their growth story. These two factors are dependent on multiple parameters including growing industry, business opportunity, scalability, sustainability, quality management, economic moat, high return ratios, low equity base, low debt levels.

Multibaggers have many common traits such as:

Growing industry: 

The sector for investment must exhibit high growth and the pace of growth should have the longevity to last for decades. The source of earning should be clearly defined. Eicher Motors happens to be one of the most popular stories about multibagger in India these days. The company owes its popularity to its motorcycle brand Royal Enfield. In November’2002, the share price of the company was at around Rs 9. As on July’21, the share price has soared to Rs. 2,700.

Business opportunity, scalability, sustainability:

 It is natural for a company operating in an industry with huge growth potential to have great fortune. If a company has the tailwinds of tremendous business opportunities and has the capability to take benefit of this in terms of building scale with a sustainable business model, it can become a multibagger. Example:  IT industry in 2000.

Management quality:

To invest in an equity is equivalent to partnering in a business. One must be very choosy about whom he/she is partnering with while making an equity investment. The promoters are responsible for the everyday management of the company. If the management is visionary and ethical, there are high chances that they will take the business to places, thus making the investment a multi-bagger. Corporate governance is of utmost importance as the business would not grow without good management.

Economic moat:

 A multibagger company should have what is called a moat i.e., an entry barrier that would prevent competition from encroaching the market. This can be in any form; brand image, patent or IP or any other significant competitive advantage. The moat provides the company with the pricing power, which can help it protect margins even in adverse conditions.

High return ratios:

 It would take no genius to figure out that companies with high return ratios generate good returns on the invested capital. Also, the return ratios should be showing an increasing trend; should not be flat or be on a falling trend. A high return ratio is a binding requirement for a multibagger stock. We can check ROE (Return on Equity), ROCE (Return on Capital Employed), ROIC (Return on Invested Capital) to see the performance of the return ratios.

Low equity base:

Companies with smaller equity base have higher chances of becoming multibaggers because of high return ratios, especially RoE, and the rise in EPS is sharp with every slight increase in profit. Always be on a look out for companies with a low equity base coupled with high return ratios.

Debt levels:

A company with minuscule debt on the books enables fast-growth earnings instead of a debt servicing company. For a company that is debt free, the revenue growth rate will percolate down to earnings if it has control over its costs.

Conclusion:

Identifying a multibagger requires lot of skill coupled with some luck. The opportunity becomes bigger if you are able to identify such companies at the beginning of their growth phase. Once you identify the right company basis some of the identifiers that we have shared above, it’s important to be patient with your investment and continue tracking for any signs of a deviation from your assumptions.

Remember the story of the bamboo plant. Take a seed, plant, water and fertilize it for a whole year, and nothing happens. In the second year and subsequent years, the same saga continues. But in the fifth year, the bamboo tree sprouts and grows 100ft in just six months! All this while, the roots are growing strong to survive. How do we find a stock that becomes a multibagger? It is equivalent to running a 50km marathon. Be thorough in your research and be patient. Remember “Rome was not built in a day”.

That’s all for today’s primer on multibaggers! Until next time, happy investing!