How to identify multibagger stocks
What is common between the stocks of HDFC Bank, MRF, Infosys, and Nestle?
Or to the relatively newer generation of investors what is common between Eicher Motors, Page Industries, and Aarti Industries?
If you had a sizeable quantity of these stocks in your portfolio, you would never have to work another day in your life. All of them have been multibaggers and have created massive wealth for investors.
In fact, the dividends from these stocks would be sufficient to take care of a major part of your expenses.
But we are talking about this in hindsight…
Not many of us would have had the conviction to buy and hold a start-up software company called Infosys or an emerging customer focussed bank by the name of HDFC Bank, back in the 1990s.
So how to find multibaggers in the future? That is the billion-dollar question.
After all, everyone wants the next HDFC Bank or Infosys in their portfolio.
The first question to ask yourself is not what to look for but where to look.
In investing once you get an understanding of where to look, what to buy becomes much easier.
Back in the 90s, Infosys and HDFC Bank were small companies in growing sectors. It was a classic case of a small fish in a big pond.
The banking sector was evolving but was dominated by large public sector banks. Back then, the customer needed the bank more than the bank needing the customer.
It was HDFC Bank who focused on the customer and built relationships. It was very atypical during those days, compared to the PSU banks and the ‘babu culture’ within them.
As they say, the rest is history…
Infosys emulated the same success on a global scale. A classic case of investing in the right sector.
The headroom for growth is the most important factor in choosing a sector to invest in and finding a multibagger stock.
It’s said a shark in a fish tank will grow only 8 inches, but in the ocean, it will grow to 8 feet or more. The shark can never outgrow its environment.
The same is true when identifying companies. Look for a small fish in a big pond rather than a big fish in a small pond.
Look at companies which are small but growing and gaining market share in industries which are expanding. The key point is the industries should be expanding.
Also, your focus should not be on largecaps when finding multibaggers.
Apart from the most important factor, which is the size of the opportunity, there are also some other ingredients which you should keep in mind.
Consider sectors likely to benefit due to tailwinds or changes in government policy.
I’m also a believer in the theory which says sectors that haven’t performed over the last 7-10 years have a high chance of delivering good returns in the next decade.
A decade of underperformance would mean many small companies in the sector would have shut shop and perished. Only the strong would have survived.
And when the good times come along, they will emerge even stronger. Imagine a small company not only surviving the competition but also the headwinds in the sector.
A case in point is real estate.
However, this is not applicable in cyclical sectors like metals and commodities. if you want to find multibaggers, these are not the places to look at.
Now that we know where to look, let’s focus on the ingredients to look out for while investing in stocks.
The first ingredient is 3 the qualities to look for in a small fish.
- A company in the smallcap/ microcap space whose products or services are gaining recognition and giving the incumbents sleepless nights. During the 1990s, it was Marico a refined edible and hair oil maker who took on the mighty HUL and beat it on its own turf.
- Companies which are creating a ‘niche’ market like Eicher Motors did with Royal Enfield. Siddharth Lal carved out a segment which did not exist in the Indian 2-wheeler market.
- Often the large companies do not focus on opportunities below a certain threshold. That is where small companies can come in and built a niche. Think of sub segments in the pharma sector like contract manufacturing, and API development.
My second ingredient is the Karta Dharta of the company: The Promoter
Unlike largecaps which have a huge organisational structure and systems in place, a small company generally relies on the acumen of the promoter.
While looking for multibaggers in the small-cap space, it’s important to focus on the jockey, more than the horse.
As, the horse gets more familiar with the race track, his performance is likely to increase but during the initial days it’s the jockey who is going to direct him.
It’s the promoter’s business acumen and the fire in his belly which will drive and steer a small company. That is what you must bet on.
One more sign I look for is promoters in a small company increasing their stake during difficult times. It shows confidence in the company.
Also, qualitative factors like frivolous expenses and a show of extravagance are generally red flags for me.
When you are building a company, being stingy is what is required.
My third Ingredient is what I call the ‘eye on the future’.
In life, your plans are the key to achieve your goals.
The same is the case with companies…
I’m talking about the capex which a company is undertaking. Whenever a company thinks its running short of capacity and demand is exceeding supply. It will undertake expansion.
As an investor, you should find companies in the process of building capacities or have recently commissioned them. The incremental growth is likely to come from these new capacities.
Also, while doing this, you should be wary of companies which undertake expansion by raising too much debt. A mix of debt and internal cashflows is fine. However, too much leverage could invite disaster if the industry slows down.
My last ingredient is what I call… cash is king and debt is hazardous.
The most important element in finance is the cash which a company generates and not profits. For a small company, what is important is cash flows and not profits. Debt is fine but debt beyond a limit, it becomes poison.
While I understand small companies need to grow rapidly and debt is a way to fuel the expansion, I have seen the smartest people too failing in life due to debt.
A company which expands using internal accruals and limited debt is a classic precursor of a multibagger.
Now, there is one quality which supersedes all of the above. If you don’t have that all the above is meaningless.
That quality is holding on to your conviction during downfall or market crash.
Multibaggers take time to compound and if you interrupt the power of compounding, the ‘multi’ in the multibagger goes away.
I’ve seen people create a fortune by holding on to Wipro shares which they had purchased during the IPO. A few thousands have grown to crores of rupees. And mind you, this is after Wipro underperformed for a long period in the early part of this decade.
Their conviction paid off. That’s the power of patience, compounding, and conviction in your ideas which creates multibaggers.
I’m sure you must be interested in knowing which sectors are the best to find multibaggers over the next 10 years.
My answer is focus on…
1) Small companies in the chemical space. A simple reason that the China plus 1 shift is happening. Now it is matter of conjecture whether it’s going to be plus 1 or plus 0.5 or plus 0.2. On a conservative basis, assume a 20% shift. An incremental 20% will be huge for Indian companies.
The goal is to look for small companies which are facing competition from China when they sell their products in India and abroad but have limited reliance on China for sourcing raw materials. This combination will go a long way.
2) Small companies in the contract manufacturing space for the mobile and consumer durable industry.
In the Roti, Kapda, Makan analogue, Roti and Kapda have been replaced by mobile and other electronics.
A massive opportunities exists as India’s per capita GDP expands. It’s said we are at an inflection point, as we cross this level. The expansion will lead to enormous spending.
While these are just few places to look for, the universe is massive and expanding.
What do you think dear reader? Where are you looking for your next multibagger?
Disclaimer: This article is for information purposes only. It is not a stock recommendation and should not be treated as such.
This article is syndicated from Equitymaster.com.
(This story has not been edited by NDTV staff and is auto-generated from a syndicated feed.)