Finding multibagger stocks is not a game of speculation. If an investor applies proper techniques and buys stocks that have specific characteristics, it is likely that he will also have a multibagger in his portfolio.
Patience and conviction are key to finding multibagger stocks
Vijay Kedia, the famous investor, recommended that investors must have patience as a virtue.
"Rome was not built in a day but Hiroshima and Nagasaki were destroyed in a day." Do read my article: https://t.co/suwTWmn2Q6
— Vijay Kedia (@VijayKedia1) March 6, 2017
According to the advice of Vijay Kedia, investors should not expect stocks to turn into multibaggers overnight. Instead, they should buy stocks are structurally strong and with good management and future strategy. Such stocks gradually evolve into multibaggers over a period of several years.
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Arun Thukral, the MD & CEO, Axis Securities Ltd, has likened multibagger stocks to a bamboo tree. He explains that like a bamboo tree, investors have to take a little seed, plant it, water it and fertilise it for five years. Then, the tree sprouts and grows to a great height feet.
In the intervening period, the bamboo tree forms and strengthens its roots and becomes strong.
It goes without saying that investors must have the conviction before making the investment. There will be several occasions where the quarterly results may be poor and show de-growth. Investors must learn to analyze the results and decide whether the poor results are an aberration or not.
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Characteristics of a multibagger stock
It is possible to prepare a shortlist of the criteria or characteristics that stocks have to possess in order for them to become potential multibaggers.
Management must have the integrity and foresight
The management is the key to how the business is run. If the promoters and the management have the caliber, vision and foresight, they can take the company to great heights.
Investors must ensure that the management has high credibility and high standards of corporate governance.
Small-caps with low institutional holding
The company must obviously be a micro-cap or a small-cap. The institutional holding should be low or non-existent. The company should be growing at a fast pace, which is higher than the growth rate of large-cap stocks.
Fast growing industry
The Company must be operating in an industry which has a high growth rate. The industry must also have longevity.
One example of this is the automobile industry which has been growing at a rapid pace and is likely to do so for long periods of time.
Even large-cap companies like Maruti Suzuki, Tata Motors and even auto ancillary stocks like Sterling Tools, Minda Industries, LG Balkrishna, Jamna Auto etc have become huge multibagger stocks over several years.
Other examples of stocks from the auto sector are Eicher Motors, Hero Honda, Force Motors etc.
Moat or protection from competition
Warren Buffett made billions from stocks because he bought stocks with a “moat” i.e. a protection against competition coming into the sector and selling the same goods at lower valuations.
The “moat” can be in the form of a technological advantage of a patent or secret process (e.g. Pharma companies like Suven or Natco) or brand image (such as Coca-Cola, Nestle, Bata).
Another example is that of goodwill that the Company enjoys and its distribution network (such as Asian Paints or Cadbury).
Examples of companies with a “High Moat Business”:
Investors looking for companies with high RoE, Profit growth faster than Sales growth on an average in last 5 years, negative working capital, low debt, consistency in profitability, dividend yield, etc can consider these stocks:
|2.||TVS Motor Co.||425.35||36.80||20,208.38||0.59|
|4.||G M Breweries||473.05||14.18||691.70||0.42|
|9.||Caplin Point Lab||387.40||44.36||2,927.84||0.31|
Scalability of opportunity
Investors have to gauge the extent of opportunity that the business offers and how scalable it is.
There are two examples of a scalable business from the past – that of the Pharma sector and the Information Technology sector. Both were highly scalable and have given huge multibagger gains to investors.
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High RoE and RoCE
It is implicit that if a micro-cap or small-cap company is operating in a business sector with high growth rate and is a dominant player, the same will be reflected in its profitability in the form of high Return on Equity and Return (RoE) on Capital Employed (RoCE). Such companies typically enjoy higher profitability than the others due to their competitive advantages and management capability.
The minimum RoE that a company should have is 15%. Anything below that indicates that there is excessive competition present in the sector.
Low equity and no dilution
Some managements have the bad habit of constantly diluting the equity by issuing new shares on a preference basis. Such companies are called “serial diluters” and can never become multibagger stocks.
The ideal stock is one which has a low equity base and has never diluted the equity.
Examples of such stocks are Sundaram Fasteners, Rane Group, MRF, Eicher Motors etc.
Sterling Tools is a company which has a low equity base and has multibagger potential. The Company has a paid up equity capital of only Rs. 6.84 crore even though it has a market capitalisation of Rs. 700 crore.
Dolly Khanna has recently bought Sterling Tools and it is in her latest portfolio.
Debt free status
The best companies are those which are debt-free and are able to fund their capex from internal accruals.
Alternatively, the company should have low debt with a debt:equity ratio of 0.5 or less.
Ambitious expansion plans
It is obvious that if the company has to grow from a micro-cap or small-cap into a mid-cap, it must have ambitious expansion plans.
Investors must keep an eye on whether the expansion is in the same sector or is a diversification into unrelated areas.
E.g. Nilkamal, which is Dolly Khanna’s portfolio stock, fell from favour when it diversified into unrelated areas of home furnishings.
Also, if the expansion is to be funded by an issue of equity or an increase in high-cost debt, it would be detrimental for the company.
Multibagger stocks bought by Rakesh Jhunjhunwala, Radhakishan Damani, Dolly Khanna, Vijay Kedia, Porinju Veliyath, Mohnish Pabrai, Basant Maheshwari
One easy way to track good stocks is to watch what stocks famous investors are buying.
The famous investors do proper screening before buying a stock. They do full due diligence into all the above aspects like corporate governance, management quality, growth prospects etc before buying the stock or recommending it for investment.
Some investors like Porinju Veliyath and Basant Maheshwari also recommend stocks for investment.
Basant Maheshwari has recently recommended PNB Housing as a multibagger stock because it has excellent management, high growth rate and reasonable valuations.
Porinju Veliyath has recommended stocks like TCI, HSIL, FCEL (Future Consumer Enterprises Ltd), Balaji Telefilms, ZEE Media etc.
Dolly Khanna has recently bought mid-cap and small-cap stocks like Sterling Tools, PPAP Automobiles, Trident Ltd, Panama Petro etc.
All these stocks are potential multibagger stocks.