The essential principles of finding 100 baggers
We need a business with a high return on capital with the ability to reinvest and earn that high return on capital for years and years.
#1 You have to look for them.
They are not obvious. Most investors may not have heard of them. They can be sceptical and cynical of their prospects.
We have to focus our efforts to hunt for these baby elephants.
#2 Growth, growth and more growth
A 100-bagger is the product of time and growth.
The companies identified must be capable of growing. It has to be good growth. Growth in revenue must be able to translate to earnings per share. We have to gauge whether the company has earnings power. As the company grows its revenue, it must be able to capture a portion of revenue as profits; measured by increasing profit margins and an above-average rate of return on capital at above-average growth rates. At times, growth in revenue may not translate to earnings as they focus on reinvesting more aggressively to grow faster at the expense of profitability. We need to assess the long-term earning capability and potential as their competitive strengths. The company must turn profitable and earnings must grow with its revenue in the longer term.
High gross margins are the most important single factor of long-run performance. The resilience of gross margins pegs companies to a level of performance. The higher the gross margin relative to the competition, the better.
There must be lots of room to expand into (i.e. total addressable market) that the companies can reinvest and keep growing.
#3 Lower multiples preferred
Lower earnings multiple, together with a good growth rate allow the stocks to reach multi-bag faster.
It is “preferred” because we cannot draw hard rules. We have to balance multiples with other factors. We should pay a healthy price for a fast-growing, high-return business than a cheap price for a mediocre business.
It’s far better to buy a wonderful company at a fair price than a fair company at a wonderful price.
Warren Buffett
Over the long term, it’s hard for a stock to earn a much better return than the business which underlies it earns. If the business earns 6% on capital over 40 years and you hold it for that 40 years, you’re not going to make much different than a 6% return— even if you originally buy it at a huge discount. Conversely, if a business earns 18% on capital over 20 or 30 years, even if you pay an expensive looking price, you’ll end up with a fine result.
Charlie Munger
There are times when companies with high multiples can still multi-bag; they are able to continue to grow and investors are confident of their growth. Monster Beverage is a good example.
#4 High returns on capital
This is encapsulated in “Lower multiples preferred” in the book. However, I find that it is important enough to warrant a separate point by itself.
When a company keeps growing its revenue with a high return on capital:
- Increased profitability: A high return on capital indicates that the company is efficiently utilizing its resources to generate profits. As the company continues to grow its revenue, it can further increase its profitability by expanding its operations and investing in new growth opportunities.
- Improved financial health: A company with a high return on capital is generally considered financially healthy, as it indicates that the company is generating significant cash flow from its investments. This can lead to a stronger balance sheet, increased cash reserves, and improved creditworthiness.
- Higher market valuation: Investors tend to value companies that consistently generate high returns on capital and strong revenue growth. As a result, a company that can maintain this growth trajectory may see an increase in its market valuation over time.
- Competitive advantage: Companies with a high return on capital may have a competitive advantage over their peers, as they can invest more in research and development, marketing, and other growth initiatives. This can help them maintain their market position and further increase their revenue over time.
An important characteristic of multi-baggers is companies with consistent revenue and profit growth and able to reinvest at a high rate (20% or better). Hence, we prefer companies that can reinvest all of their earnings. If they pay dividends, that is less capital available to reinvest. Dividends become a leakage and an expensive luxury for an investor seeking to maximise growth.
While dividends are a drag, borrowed money is an accelerant when the company has a good track record of achieving high returns on capital.
Share buybacks can also accelerate the compounding of returns when (a) the company has available funds beyond the near-term needs of the business and (b) finds its stock trading below its intrinsic value, conservatively calculated. When we find a company that has its shares outstanding lower over time and seems to have a knack for buying at good prices, it is worth looking at.
#2 + #3 + #4 together = Engines of a 100-bagger
Growth + Low multiple + High return on capital can propel the stock to multi-bag easier and faster.
As seen above, MTY Foods’s path to 100-bagger is propelled by its P/E increasing faster than its earnings growth which increases faster than its revenue. At the start of 2003, it was a small company, unheard of, not obvious and not proven; P/E was low. As its revenue continued to grow consistently and its earnings per share increased at a faster pace, the market noticed its potential and kept buying higher; giving it a higher P/E. As its revenue continued to grow over a longer period and EPS increased faster, the market became more confident of its consistent growth and durable earnings; they were willing to buy at a higher share price with a higher P/E.
Similarly, Monster Beverage’s success is a combination of rapid increase in sales, rising margins and profits and a rising ROE.
#5 Economic moats are a necessity
A truly great business must have an enduring “moat” that protects excellent returns on invested capital.
Warren Buffett
A 100-bagger requires a high return on capital for a long time. A moat protects a business from its competitors and allows it to achieve multi-bagger. Hence, it is important to study the kind of moat a company has; how the company create value for many years ahead to multi-bag.
Moats take various forms such as:
- A strong brand
- High switching costs
- Network effects
- Low-cost advantage
- Size advantage
Michael Mauboussin did some studies on moats:
- Some industries are better at creating value than others. In other industries, some sub-segments are better than others (airlines versus, aircraft lessors, manufacturers, part suppliers).
- Industry stability determines the durability of a moat. Stable industries (beverage) are more conducive to sustainable value creation. Unstable industries (smartphones) present substantial competitive challenges and opportunities.
#6 Smaller companies preferred
Smaller companies have greater rooms to grow compared to those with much larger revenue and market valuation.
As a general rule, the author suggests focusing on companies with market caps of less than $1 billion. Not a necessity; it is “preferred”.
#7 Owner-operators preferred
Many great businesses have an owner with vision, tenacity and skill and skin in the game at the helm.
It is preferred but not required.
#8 You need time: Use the coffee-can approach as a crutch
We need patience and time. Even the fastest 100-baggers need about 5 years to achieve. A more likely journey will take 20 to 25 years.
We need to have a way to defeat our own instincts — the impatience, the need for ‘action’; the urge to do something.
Take some portion of your money, find the best stocks and let them sit for 10 years — the concept of a “coffee-can portfolio”. The essence of the coffee-can idea is to protect yourself from the emotions and volatility that make you buy or sell at the wrong times. Bullishness or bearishness does not enter into it. At the end of 10 years, you see what you have. The coffee-can theory assumes that you will do better this way than if you had tried to manage your stocks actively.
You only need to put a part of the money in the coffee can. It does not have to be the only investing approach; it can be one of several. Do not let the fear of apocalypse keep you from building a coffee-can portfolio of 100 potential baggers.
Having multi-baggers is possible. We have seen many listed companies achieving multi-baggers, 100 baggers and more. Time to try and experience the possibility ourselves. Buy right and hold.
#9 You need a really good filter
There is a world of noise out there. Every day, something important happens or so they would have you believe. The financial media narrate every twist and turn in the market. There are regular Fed meetings and a stream of economic data and reports.
It is a distraction in our hunt for 100 baggers. All the intense watching would have been a waste of time. The attempt to trade it would have been a mistake. We should have just left them alone.
Another temptation is to get too concerned over where the stock market is going.
Don’t fret so much with guesses as to where the stock market might go. Keep looking for great ideas. If history is any guide, they are always out there. Have a really good filter to find them.
#10 Luck helps
No one could predict in 2002 what Apple would become.
We can have a really good filter to identify the 100-bagger potential. In order to grow, the visionary leaders of the companies expand into new areas with new products and keep improving with new versions and models. Thereon, they move to adjacent with new products, versions, and models. Gradually, they become multi-baggers doing many different things.
We identify the potential 100-baggers. Just buy and hold on and let their great and visionary leaders do wonders and good luck for us to realise the great 100-bagger potential or more. 🙏
#11 You should be a reluctant seller
An anecdote by Chris Mittleman, an exceptional investor, was published in one of his shareholder letters. An excerpt appeared in Value Investor Insight:
Imagine if a friend had introduced you to Warren Buffett in 1972 and told you, “I’ve made a fortune investing with this Buffett guy over the past ten years, you must invest with him.” So you check out Warren Buffett and find that his investment vehicle, Berkshire Hathaway, had indeed been an outstanding performer, rising from about $8 in 1962 to $80 at the end of 1972. Impressed, you bought the stock at $80 on December 31, 1972. Three years later, on December 31, 1975, it was $38, a 53% drop over a period in which the S&P 500 was down only 14%. You might have dumped it in disgust at that point and never spoken to that friend again. Yet over the next year it rose from $38 to $94. By December 31, 1982, it was $775 and on its way to $223,615 today—a compounded annual return of 20.8% over the past 42 years.
The first rule of compounding: Never interrupt it unnecessarily.
Charlie Munger
Here are the reasons to sell:
- You made a mistake. It is less favourable than originally believed. A mistake is not when a stock is simply down in price.
- The stock no longer meets the investment criteria.
- You want to switch to something better.
Here are not valid reasons to sell:
- My stock is “too high”. *
- I need the realised capital gain to offset realised capital losses for tax purposes.
- My stock is not moving. Others are.
* There are times when the stock is too high — trading at a ridiculously high valuation. Unless you are experienced and capable of timing the market by selling high and buying back low, do not interrupt; just leave it alone. It is easier said than done.
If you are hunting for 100 baggers, you must learn to sit on your ass. Buy right and sit tight.
Beating the market ≠ Beating the market consistently
100 Baggers is a long game. There are approaches and investors who have beaten the market by a solid margin over time. The thing is, they seldom beat the market consistently. The best investors lag the market 30-40 per cent of the time.
Studies of 100-baggers
In “An Analysis of 100-Baggers“, Tony drew four conclusions:
- The most powerful stock moves tended to be during extended periods of growing earnings accompanied by an expansion of the P/E ratio.
- These periods of P/E expansion often seem to coincide with periods of accelerating earnings growth.
- Some of the most attractive opportunities occur in beaten-down, forgotten stocks, which perhaps after years of losses are returning to profitability.
- During such periods of rapid share price appreciation, stock prices can reach lofty P/E ratios. This shouldn’t necessarily deter one from continuing to hold the stock.
In Motilal Oswal’s study of 100 baggers in India, it concluded that the single most important factor is “Growth” in all its dimensions — sales, margin and valuation. Their analysis of the 100x stocks suggests that their essence lies in the alchemy of five elements forming the acronym “SQGLP”:
- S: Size is small.
- Q: Quality is high for business and management.
- G: Growth in earnings is high.
- L: Longevity in both Q and G.
- P: Price is favourable for good returns.
In a study “10x return stocks in the last 15 years” by Kevin Martelli at Mrtek Partners, he summarised the idea:
To make money in stocks you must have “the vision to see them, the courage to buy them and the patience to hold them”. Patience is the rarest of the three.
Here are some conclusions:
- There is no magic formula to find long-term multi-baggers.
- A low entry price relative to the company’s long-term profit potential is critical.
- Small is beautiful: 68% of multi-baggers in the selected samples are below a $300 million market cap at their low.
- Great stocks often offer extensive periods during which to buy them.
- Patience is critical.
In another study by Hewitt Heiserman Jr., titled “Ben Graham and the Growth Investor.” An obvious trap he observed is that investors often overpay for growth. When we pay a growth company with higher multiples, the share price upside potential can be limited. Worse, overvaluation means high expectations that the company must achieve or exceed. Some traps to take note of:
- Earnings omit investment in fixed capital, so when capital expenditures are greater than depreciation, the net cash drain is excluded.
- Earnings omit investments in working capital, so when receivables and inventory grow faster than payables and accrued expenses, the net cash drain is excluded.
- Intangible growth-producing initiatives such as R&D, promo/advertising and employee education are expenses (i.e. not investments), even though the benefits will last for several accounting periods.
- Stockholders’ equity is free even though owners have an opportunity cost. In other words, companies can spend $50 to create $1 in earnings. If all you look at is earnings per share, then you will ignore the cost to generate those earnings.
In short, we cannot focus on earnings alone.
Conceptual power is more important. There is no amount of security analysis that is going to tell you a stock can be a 100-bagger. It takes vision and imagination and a forward-looking view of what a business can achieve and how big it can get. Investing is a reductionist art and he who can boil things down to the essential wins.
Related post: Multi-baggers with growth companies
It is possible; give it a chance.
There are companies we know that have been growing and achieving multi-baggers. Most of us know and are familiar with the essential principles mentioned above. However, few have multi-baggers.
It is possible. Start small and put the principles to practice with the coffee-can approach. Start with a small amount of money, invest in potential multi-baggers and hold. Use the opportunity to start small, experiment, keep learning and pivot. Once we are confident and happy with the approach, we can scale with more capital and this multi-bagger approach.
All great companies started as small companies.
Ian Cassel
