What investor doesn’t want a stock that keeps giving? That is what exactly a multibagger stock happens to be if you are lucky as an investor to spot one or many.
What Is A Multibagger Stock?
First used by Peter Lynch in his book ‘One Up On Wallstreet’ ‘Multibagger’ stocks are stocks that return several times their investment, that is, 100 percent higher returns or more in a relatively short time. So for example if a stock gives you twice the returns then it is a two-bagger, if it gives you thrice the returns then a three-bagger or four-bagger, so and so forth. These stocks are undervalued with great fundamentals and high growth potential waiting to be discovered by the investors.
Investors looking to build capital with decent risk appetite aim to get their hands on multibaggers. But the catch is- a multibagger is a multibagger only in hindsight. At first, it may look like a risky undertaking in an overstimulated market environment.
Examples Of Multibaggers
Examples of multibaggers in India include Uniply Industries that returned more than 1400 percent, a fourteen-bagger, in one year in 2015. Some popular multibaggers in Indian stock markets in 2020 were Caplin Point Laboratories which returned 22,300 percent in ten years; La Opala RG, rising 4500 percent in the previous decade; or Garware Technical Fibres that has returned 2600 percent in the last ten years.
Investors do need to practice caution in assessing multibaggers. There may be multiple underlying factors responsible for a stellar performance like base effect and high growth potential. But past performance in case of multibaggers can hardly be a guarantee of similar performance in future.
How to identify multibagger stocks?
- Debt on the books
Investors need to keep an eye on the company’s debt to equity ratio. Being overleveraged could pose operational risks for the company at a later point in time. The debt to equity ratio also differs between industries, but experts suggest, broadly, debt to equity ratio should not exceed 0.3. Instead, look out for companies that are generating a consistent return on capital. If the growth comes on the back of capital infusion alone without innovation or ROC increase, the company is likely to become a default risk.
- Look at revenue multiples
A company’s revenue multiple is the value of its equity relative to the revenues. If a company has a low revenue multiple, it is considered as a cheap proposition. It such a company has strong fundamentals; it may indicate growth potential.
- Study the PE ratios
It will take you a step closer to identifying a multi-bagger if you study their current price-to-equity ratio. A company’s price-to-earnings ratio is the ratio of its share price and earnings per share. One of the indicators of a multi-bagger is if the PE is growing faster than the stock price.
- Look at stocks that are undervalued
Cheap valuation may not necessarily be a bad thing. If a stock is overvalued, the investment bubble may burst, and investors may end up being disappointed with the drop in valuation. But if a stock is undervalued, and the company has good fundamentals, the valuation could be revised in the future, and the investors may end up benefiting from it.
- Pick a strong industry
Pick a multibagger in an industry that is looking to grow substantially in the next five to ten years. If the industry is showing signs of having topped out growth-wise or if the industry has strong economic or policy hurdles, it may be far more complicated to pick a multibagger in such an industry.
- Look for a company with a strong competitive advantage
Look for a company with what Warren Buffet calls ‘economic moat’ or a competitive advantage preserved by a company to keep drawing in profits in the long term. The economic moat boosts growth and profitability of the company over its competitors. This could be a significantly high market share, low-cost production, scalability, strong brand leadership, patents and intellectual property, R&D investments, solid distribution network and no policy drawbacks.
- Have patience
For investors to benefit from having multibaggers in their portfolio, they need to exercise patience. A spot trade on multibagger, however reasonable the price, will benefit you little, and may not even give you higher returns. It may be a good idea to be able to hold on to the winners in the long run.
- Management is key
Look at who is leading the company, their management practices, stability, vision for the company, shareholder and dividend policies, and corporate governance. Look for management that has shown expertise in navigating economic downturns and other business crises successfully. If a company changes its business model too frequently, it may be a red flag for investors.
A few multibaggers can boost the overall returns of your portfolio, but the technical trend analysis and research behind picking a winner are necessary and will give better results.