Understanding Multibaggers and decoding the patterns associated with it

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Understanding Multibaggers and decoding the patterns associated with it

May 06,2019 admin 0 Comment

Points to note over here and Possible Scenarios:

Understanding Multibaggers

“Multibagger” the sheer name thrills investors. No wonder it has become the most used or abused word in the stock parlance today. Multi-bagger, as the name suggests, is used for stocks which may create multiple bags (multiply money) over the next few years for an investor. This is the term mostly used to describe those stocks which have potential to report explosive growth over a prolonged period of time.

TTK Prestige, a leader in the Indian kitchenware market, is one of the stock in the list of multibaggers, with compound annual returns of 58.5 per cent in 10 years. In other words, Rs 1,000 invested in 2005 is valued at Rs 1 lakh today. A 100-Bagger stock in 10 years. This is just one of the many examples. There are companies which have given much better returns than TTK Prestige during the same period. Do you know, Symphony has given compounded annual returns of an astonishing 111.7% in the last 10 years? Investment of Rs. 1000 in Symphony in 2005 is valued more than Rs. 18 lakhs today. Mind boggling, isn’t it? There are many more in the list.

Now at the hindsight it’s easy to find multibaggers, but really difficult to find through foresight. And here comes the con men. In the garb of finding and suggesting multibaggers they fulfill their own vested interest. If you look historically too, something that is not really understood but much well deserved (Say God’s blessings) has always been the main recourse of coning people. I am avoiding the obvious religious example to avoid trouble J. The same thing can be seen in stock market too.

Questions to Ponder before embarking the journey to unearth Multibaggers

Here’s a look at the top 5 important questions that any enthusiast must ask before investing in their money for stock purchase. Investment, for most individuals, is about spotting the best stocks to purchase. Actually, the main concern is to determine how to make real profits from the type of stocks to make investments in. When you are trying to buy stocks in India, it is essential to answer these 5 important questions.

  1. Which stocks should you purchase?

Every stock investment involves plenty of decisions. You have to find businesses that are sound in operations and finances, and are run by a reliable and capable management team. Look for stocks of businesses that are well recognized and financially strong. These stocks tend to do well over a long period. You need to invest enough time and skills to find these businesses.

  1. What are the prices of stocks?

Even after you identify the best stocks it is unwise to immediately purchase them. You have to evaluate their costs and find out whether the pricing is right. It is possible by conducting proper research about business competitors, financial parameters, sector analysis as well as different types of factors that can have an impact on the company stock. You should determine whether the stocks are overvalued or undervalued, or valued fairly.

  1. When should you purchase chosen stocks?

Once you are aware of the stocks to purchase and the prices to buy them in, the stocks of choice can be undervalued or overvalued. As an intelligent investor, you should always purchase stocks when they are undervalued.

  1. How much time to hold the stocks for?

Equity investment is most preferable for long-term. If you choose a stock with care and are prepared to hold company stocks for a minimum of few years, there is high potential for profit generation. An undervalued stock can take some years to reach its complete potential – whether it comes to growth in valuation or business. You should hold stocks of well established businesses for 3 – 5 years at minimum, particularly if you have confidence about a growth in their valuation and expansion.

  1. When is the best time to sell stocks?

The sale of a stock is important for achieving your profits and progressing with your wealth generation. If you do not immediately need money for any emergency purposes, it is wise to only sell your own holdings when there are minimal prospects for future growth, previous growth in business has not satisfied expectations or the valuation of the stocks has become too high and you can find investment options with more reasonable valuation.

A Step-By-Step Method of Finding the Best Multibagger Stocks

There is an illustrious list of investors who have gained fortunes from multi-bagger stocks making these stocks one of the most sought-after investment options. However, it is important to understand what a multibagger is and the basics of investing in these stocks. In simple words, multi-bagger stocks can be defined as stocks that can produce big profits and can get back manifold returns in a couple of years.

Though these stocks are desirable and worth aiming for, investing in Multibagger Stocks requires a deep understanding of the market trends. Multibaggers are the ultimate investment option for you, if you are looking for a low-risk venture that would give you return in a year or two and if you want to keep your distance from market volatility. Here is a step-by-step method that will help you in finding the best multi-bagger stocks and help you gain a better perspective.

Years of studies have shown a few definitive patterns that is visible in all the unknown stocks that went on to become multibaggers from just nowhere. We have tried to list down 10 common patterns that are visible in the early stages of Multibaggers. One should always apply these thumb rules to see if the stocks they have chosen comply with these patterns.

  1. An unknown name:

    Generally the retail market gets to hear about around 1500 stocks. It is seen that at early stages, Multibaggers are generally unknown by common mass and even DII and Analysts.

  1. Low Equity base:

    Lower the Equity base, higher the earning per share (EPS) and higher the valuation and hence higher the probability of the stock to become a multibagger.

  1. High Promoter Holding:

No one knows the Company better than the promoters themselves. Having the own skin in the game indicates that the promoters have a firm belief in the future plans and strategies of the Company. Besides, a higher promoter’s holding means lower floating stock and hence stock price can shoot up if y-o-y and q-o-q results are good and as it becomes known to everyone.

  1. Size of opportunity in the business sector

    Choosing the right sector is as important as selecting the right potential multibagger. There are few sectors where the size of opportunity is huge. Multibaggers generally operate in those businesses. If a company belongs to an industry that has promising prospects, choosing the company would be a wise option. However, keeping a tab on the government policies is important in this case. Some examples include Vardhman Textiles and KPR Mills that are possible beneficiaries of the Modi government’s emphasis on the textile industry to create more employability.

 

  1. Earning Visibility

    Investors must search for companies having a robust business model with promising earning visibility going forward. The profitability of a tool is an active indicator of the potential of the stock. The Earnings per Share (EPS) and Profitability after Taxes (PAT) should be growing on a yearly basis. Another tool, Operation Profits indicates that the demand for the company’s product is growing and this demand boosts in the growth of the company as well.

 

  1. Price – Earning Ratio (PE Ratio)

    PE is generally indicative of the valuation of the Company. Higher the PE of the stock, more is the stock expensive. If a company has good business model, strong fundamentals and balance sheet backed by positive cash flows and if such company is quoting in lower PE range then we may look at such stock to see the multibagger potential. It is important to equate the P-E ratio of the company with that of the industry so that a clear picture of the growth potential of the stock can be obtained. This ratio tells you how many years it will take for your investment to return capital invested at constant earnings. Ideally, the P-E ratio of a stock should be lower than the industry P-E. A low P-E value is usually a good signal unless the business is growing at a rapid pace.

 

  1. Price to Book Value ratio (P/BV)

    if the price of a stock is much below the book value then the investor must dig deeper to find out the potential of the stock in becoming a multibagger. Price to Book Value ratio of around 0.5 – 1.0 is the ideal case. If it is too high then in all probability it is trading at a higher valuation. If it is too low, then there might be some real reasons behind it and hence unearthing the reason is important before jumping to a conclusion.

 

  1. Zero or negligible Institutional holding

    This one is crucial for the obvious reason that a ‘discovered’ and well researched stock would in all probability be having an institutional support. So, the investors need to look out for the stocks having virtually no institutional holding. Money is made when you enter before the big institutions do.

 

  1. Positive Cash Flow

    Needless to mention investors need to take a hard look at companies having consistent positive cash flow for the past several years backed by the above factors. However, one must understand the cash flows before concluding anything. The Company may have a lower cash flow when it is in an investing or an expanding phase. Importance must be given to operating cash flows.

 

  1. Decent return ratios 

    This is a proxy to understand management capability. In an unknown company it is difficult to find about promoters and their abilities. Hence, ROE and ROCE give you an indication of management’s financial prowess and their ability of smart money allocation.

No stock would probably comply with all the above mentioned patterns. The more number of points it clicks more are the chances of it becoming Multibagger. Hence, please do not expect your stock to comply with all the 10 points as mentioned above. The more it does, higher your conviction should go up.

Types of stocks that can become multibaggers in Short Run

 Besides, the traditional methodology of finding multibaggers, there are special situations which warrant fast multibagger returns in a short span as well. Lets first understand what kind of stocks can give multibagger return. To my mind there are basically 3 types of stock that gives multibagger returns

  1. Unknown stocks that suddenly becomes big

    For example take TTK Prestige, Page Industries, Kitex garments and many many more. This is the most common way that Indian analysts try their shot to glory of finding multibaggers. I feel this is difficult but no doubt this gives maximum kick as an investor.

 

  1. Good stocks in bad days

    Well known stocks ignored, misunderstood or abandoned.  This I am covering in my Abandoned Gems Series. Selan was the first stock recommended in this.  You guys may remember sometime in July 2012 there was a huge ruckus is Maruti Manasar plant. The plant was shut down and the stock fell by 11%. I scooped up a good chunk of Maruti at Rs. 1100. Sold it in 2015 July around Rs. 4200. Cool 4 bagger in 3 years. That too for a safe and sound stock like Maruti. I feel this is the easiest way of laying your hand on a multibagger.

Keep a list of 50 fundamentally great stock handy with you. Wait for them to go through a bad time ( Believe me like all of us all stocks go through their own bad times) and scoop them up with your eyes closed. I feel this is an easy cheat code to find multibaggers.

  1. Turnaround stocks 

    Due to change in management, business scenario, technology, merger and demerger, Govt policy changes and many other internal and external factors stocks fortune change. From duds they slowly become race horses from huge losses they start posting mind blowing profits. Take for example Mangalam Drugs from losses in 2013 and 2014 it has started posting steller results and stock price too is running crazy. I feel this is very difficult for retail investors to spot and get convinced about. Remember Buffet saying “Turnarounds seldom turn around”.

Now that we have understood both the traditional way of find multibaggers as well as the special situations to take advantage of; it makes sense to look at a conventional “formaula” that has been used in the past to find out potential multibaggers.

They say a formula is needed to unearth a multibaggers and magic is what you need to get multibagger returns and beat the market consistently. Magic Formula is exactly supposed to do that.

Magic Formula and Multibaggers

As a result of brilliant marketing, promotion and becoming a New York Times bestseller in 2005, Joel Greenblatt has turned the Magic Formula into a key strategy for many in the value investing and mechanical investing community.

The book says – “Buy at least 20 stocks from the Magic Formula screener and then re balance at the end of the year. Do this and you will beat the market.” Greenblatt wrote The Little Book that Beats the Market for his children who were aged between 6 – 15 years at the time.

It’s written in plain English. and 6th grade mathematics proficiency is needed to make it easy to follow along. This is the perhaps the strongest point of the Magic Formula theme. Everything is very easy to understand. The concept is simple, the explanation is simpler; but most important of all, the execution strategy suggested for investors is the simplest to do on their own.

Greenblatt has described the Magic Formula in it’s most naked form as:

“a long-term investment strategy designed to help investors buy a group of above-average companies but only when they are available at below-average prices.”

The Ingredients to the Magic Formula

Here is the formula courtesy of wikipedia. From beginning to end, it consists of 9 steps.

  1. Establish a minimum market capitalization (usually greater than INR 350 crs).
  2. Exclude utility and financial stocks
  3. Exclude foreign companies (American Depository Receipts)
  4. Determine company’s earnings yield = EBIT / enterprise value
  5. Determine company’s return on capital = EBIT / (net fixed assets + working capital)
  6. Rank all companies above chosen market capitalization by highest earnings yield and highest return on capital (ranked as percentages)
  7. Invest in 20–30 highest ranked companies, accumulating 2–3 positions per month over a 12-month period
  8. Re-balance portfolio once per year, selling losers one week before the year-mark and winners one week after the year mark
  9. Continue over a long-term (3 – 5 year) period

Pay close attention to step 4 and 5 because they are the key driving formulas for it all to work.

  • Earnings Yield = EBIT / Enterprise Value
  • Return on Capital = EBIT / (Net Fixed Assets + Working Capital)

Magic Formula Results:

Starting with $10,000 in 1988, the Magic Formula would have made you a millionaire by 2009.

The Magic Formula is famous for returning a 30% CAGR. From 1988 to 2004, it did achieve a 30.8% return, but the CAGR declined after that. Though the latest book give results till 2009 only, the recent results are not known. However the fact remains that this formula really does work magically.

Multibagger Knowledge Series

I found that the so called “stock market babas” advise a lot of junk garbage companies which the retail investors buy in upper circuits. While the babas selling and laughing their way to the banks, the retail investors find themselves in huge losses and missing out on the big bull run while staying invested in these junks. You will be surprised to know, I found almost 80% of money of all the portfolio I have reviewed have gone into attempted multibaggers.  Obviously there are a few exceptions. The idea for this ‘Multibagger Knowledge Series’ stuck me while realizing that practical knowledge sharing is the need of the hour.

  • What if there is an easy to understand step by step guide to finding multibaggers?
  • What if there is a checklist to pass all your stock ideas though to understand if your stock can become a multibagger?
  • And finally, What if there is hand-holding and clear do’s n don’ts provided to u while finding multibaggers?

The answer is simple. We all can find multibaggers then.

I am kidding. It’s still not that simple. But your attempts become better for sure. You become a better investor for sure. It becomes difficult to con you for sure.

I believe that’s a big big achievement.

So, here introducing Multibagger Knowledge Series with objective of making you a better investor and a harder nut to con.

We will have a series of blogs coming in this to take you through the professional ways of finding multibaggers from a multitude of stocks available at the market. At the end it would become a great checklist for you to vet your stock ideas.

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