What are multibagger stocks?

What do you expect when you invest in a stock? Returns, of course! But what are the returns that would make you happy – 10% or 50% or 80% or 100% or more? Naturally, returns would make you happy, but it's also natural for you to wonder whether a stock can generate returns of 100% or maybe even more.

So, can they?

The answer is yes! Such stocks are known as multibagger stocks. In this blog, we look into multibagger stocks: their key attributes, some myths, and risks associated with them.

Let's dive straight in.

Understanding multibagger stocks?

Peter Lynch coined the term multibagger stocks in his 1988 book 'One Up On Wall Street.' An equity stock that generates a return of more than 100% is a multibagger stock. A 100% return from a stock implies that the investment in such a stock has doubled. 

Two-bagger stocks are stocks that double their price while ten-bagger stocks generate ten times the price. Therefore, multibaggers are stocks whose prices have risen multiple times their initial investment values.

Characteristics of a multibagger stock

The following information usually serves as the precursor to a multibagger stock:

The market leaders: More often than not, multibagger stocks are of companies that are the market leaders in their business domains. Market leaders do not necessarily mean that the company needs to have a huge market cap. One of the best ingredients for multibagger stocks is a company with market leadership and a small-cap. 

One such example is PPAP Automotive - a market leader in sealing system solutions for cars. Its market cap was Rs. 100 crores, but it piqued analysts' interest when its market cap went over Rs. 580 crores.

A sturdy business model: A debt-free balance sheet with a high RoE is the first sign of a robust business model. You know you're close to finding a multibagger stock when you combine a market leader with a debt-free small-cap which generates a higher RoE. 

Promoters and management: An efficient promoter and management (of CEOs and MDs) significantly influence the company valuations, other than EPS, because the markets tend to give higher valuations to the companies with reliable and credible management. Investors can feel secure on this front by listening to conference calls and tracking changes in promoters' shareholdings.

The earnings growth potential: The one thing that either makes the stock or breaks the stock is earnings. What the earnings do today, tomorrow, or the next day is a matter of mere distraction. Thought has to be put into how much a company has to earn for its market cap to increase 10-15x. If you believe that the company shows such potential, then you have a multibagger.

Trends as indicators: Sectors with an upside trend usually birth multibaggers. Trends are always available to play in the market. The caution has to be taken not to buy the stocks once the trend is over. 

Valuations as indicators: Deep valuation discounts compared to peers and industry coupled with earnings growth can create multibagger stocks.

Holding period as indicators: Time is more critical in the stock market than timing the market. A stock may generate returns of 200-300% in 3 months as well as 3 years. Such results in 3 months are seen in case of few stocks among millions. If you see enormous potential in a company, you should invest for at least 2-3 years (long term goal). You may get multifold returns within months, but you cannot invest expecting multibagger returns.

How do you find multibagger stocks?

There are no set rules for spotting a multibagger stock. However, the following are the known traits to spot multibagger stocks:

Growth at a reasonable price (GARP) stocks: Investing in stocks with both the characteristics – growth and value – instead of investing entirely in growth or entirely value stocks is always better. This can help you find a company with a growth potential without overpaying for it.

Turn-around stocks: These are the stocks of the companies that were once severely beaten by the market but have started to pick up.

Mis-priced opportunities: Multibagger returns can be found can be reaped by investing in those companies that show growth potential but are ignored by the market or have fallen out of favour of the investors.

Changes in the organization's structure or management: Major changes in the company's key management or its structure can drive growth and indicate a potential multibagger.

Sustainable competitive advantage: A company that enjoys a one-of-a-kind status and blocks the entry of new competitors into the market shows the potential of generating multiple times return in the future.

What are the cautions to be taken?

Investing in multibaggers sure sounds like a just-grab-it opportunity. But investors should take the following precautions:

Entering at the right time: As we've already discussed, time is of the essence in the stock markets. Most investors enter when it is time to exit. You enter a bull-trap if you don't do an advanced analysis of the stocks before entering the market. You shouldn't take exposure in stocks who's 'high' (trend story) is fizzling out.

Beware of market gimmicks: It may so happen that a particular stock is advertised as a multibagger contrary to reality. Investors in good faith expose themselves to these stocks only to realize later what really happened. 

So, what can you do? Well, be patient and check the facts and figures – if it is a multibagger stock, it will make you huge sums of money even if you buy after a rise of 50%.

Let's do some myth-busting about multibaggers:

It's been in the media/social media – it must be legit: Just because a stock has been in the news or making rounds on various media platforms does not mean it is a multibagger. We've already discussed how gimmicks-influenced investing can be harmful to your investments.

I haven't recovered my capital. I won't sell: If you agree with that statement, the egomaniacal side of you has taken the lead. Proper analysis should drive your investment decisions. An analysis can be faulty as far as future projections and moving parts are concerned. In such cases, it is wise to use the information at hand instead of simply holding on in the hopes of recovery. 

It looks like a multibagger. Let's borrow money to buy more of it: Stockbrokers and fund houses may suggest this to dump their stocks and fool the investors. Whenever you come across such a statement, be very careful and conduct a proper analysis before making any decision.

Closing remarks:

You do not have to be a genius to make money in the stock market. What you need to be is careful, carry out a proper analysis and know all the facts and figures before making an investing decision. With this article, we tried summarizing certain precautions investors need to follow before picking a stock. 

Stay Positive, Test Negative!

Happy Investing!