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Sunday 26 August 2018

Weekend podcast in ET Markets titled "How you can spot multibagger stocks"

You can listen to my latest weekend podcast in ET Markets titled "How you can spot multibagger stocks"

According to you, what is the definition of multibagger?

I think the term multibagger was made famous by Peter Lynch in his book One Up On Wall Street. He called stocks which doubled as 2-baggers and those that went up say 10 times as 10-baggers. To me, a multibagger is a misnomer. People assume multibagger with quick gains in the market, which is not really the case. People ignore the time element. Even a bank FD is a 2-bagger in 8-10 years! So, an absolute return value is meaningless without the element of time. To me, multibaggers are those which generate very good compounded returns for long periods of time. For example, stocks like Asian Paints, HDFC Bank, which have delivered superb returns over 20+ years to people who have held on to them over the entire duration.

How one can spot big compounders on D-Street?

There is no magic formula. Otherwise, everyone would be able to identify them. But if you think about it, what are the key ingredients required. For generating good revenue and profit growth over a long period of time, you need a stable industry, very large opportunity size, large profit pool and companies with a differentiated product or service which are able to take market share from its competitors. 

The second aspect you need to think about is the price you pay while buying. You will need the valuation, for example, the PE multiple to be at the same level or higher when you want to exit as compared to when you are buying. So, it makes sense to buy when the PE is low. That way you have a buffer for the possibility of you being wrong, what we call a margin of safety.

You also need to ensure the basic hygiene factors like low debt, high ROCE, good management are in place. Management needs to be a minority shareholder friendly. Remember the quality of management matters the most when the investment horizon is very long. 

Another misconception which I see a lot of people have is that only unknown and obscure small caps can be multibaggers. Like the examples of Asian Paints or HDFC Bank that I gave earlier, they were known stories even twenty years back. But importantly, they have been able to continue to execute well and outperform. So for good compounders, you need not look only at small caps and unknown names.

What kind of study one needs to spot such stocks?

As I mentioned earlier, to spot good compounders, you need to understand the industry in operates in quite well. You need to have a view on the longevity of the business and the absolute level of profit the company can generate. For example, ask yourself if the company can grow to 10 times its current profits? What is required to happen for it to grow that much? Who are the major competitors? Is the company able to take market share from its competitors? Is there any global example in another country that can be used as a reference point for this kind of growth? 

An interesting approach is to make a list of some great businesses. Then study them thoroughly. Make notes. Do a valuation. Then wait for the time when the overall market corrects, to buy the company, if it gets close to your valuation. My experience is that the market gives an opportunity at least once a year or once every other year when there is a steep correction. That is the time to load up on the stocks which are part of your Great Companies list.

As a value investors, where do you see opportunities right now?

It continues to be a struggle to find good compounders in the market today. Valuations for most good companies are still quite elevated, even after the fall in the broader markets. Having said that, I believe that there are still pockets of opportunity, especially in sectors like Pharma, Chemicals, Real Estate and IT. I think as an investor you need to spend time in understanding individual businesses and industries and always be on the lookout for great companies available at reasonable prices. As Peter Lynch said, "The person that turns over the most rocks wins the game." And finally, be patient till you find the right business to invest in, at the valuation where you are comfortable holding for the long term.

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