How to Spot a Multibagger

Multibagger

A Multibagger in stock market parlance is a stock that can return multifold returns when invested in it. The holy grail of investing is to identify such multibaggers and hold them in your investment portfolio.

To spot a multibagger needs a thorough study of multiple fundamental parameters, a few of which are listed in this article. Please note. However, we cannot be rigid on any of these parameters. We need to be flexible to interpret things from a bigger picture point of view.

So what are these parameters of a multibagger stock that we should look for?

No doubt about business survival.

Identifying a  multibagger begins with identifying a business that can weather the test of time. Whether there be a health crisis, economic crisis, or political crisis, these businesses should not have any difficulty in surviving. When I was young, my father told me that to survive, humanity will always need food and consistently invest in promising companies that cater to the hunger of the masses.

There are many other businesses, apart from those in the food industry that can survive and thrive in adverse circumstances. The health sector is one; the information and technology sector is another. There may be sectors that will come up in the future; you may be aware of them due to your line of work. Look into those businesses.

Visible & sustainable growth potential

Most businesses are not built because the management wanted them to remain stationary. Entrepreneurs and management want a steady and sustainably growing business. Look for companies that are growing at a fair clip with good management. 

A management team that continuously innovates and optimizes its core business should provide profitable growth for investments in the company. A management team that is not focused is a poor innovator, and does not optimize resources, may give spectacular returns in the short term, but may not be able to sustain in the long run. Such businesses usually do not provide multibagger returns.

Management has a vision of growth.

Identifying potential in future markets is a must for any good management. The company should not bask in the past and should be forward-looking to identify the ideal growth opportunities. The management should be ethical and provide adequate consideration for every stakeholder.

Reasonable Promoter stake

There should be fair skin in the game from the promoter.  Many successful investors avoid companies that have a very low promoter stake. Ideally, the promoter should have at least a 50% holding in the company, and the higher this number, the better it is, and the likelier it is to end up as a multibagger. If in case there is a low promoter stake, then promoters should increase stake at every possible opportunity. Also, pledging should either be zero or minimal.

Debt zero or going towards zero

Debt is becoming a dirtier word at the individual as well as at the corporate level. A Debt to equity ratio of less than 0.5 should be an ideal investment; however, do remember that smaller companies that are growing fast may not always be debt light—most of the time, the lower the debt, the better the valuations.

Increasing cash flow

At the most fundamental level, a company’s ability to create value for shareholders is determined by its ability to generate positive cash flows, or more specifically, maximize long-term free cash flow (FCF). If the cash flow of a company is increasing, it means that the company is growing well and can use the amount to grow itself further.

Rare equity dilution

The lesser the equity dilution, the better will be the valuations. Stock dilution, also known as equity dilution, is the decrease in existing shareholders’ ownership percentage of a company due to the company issuing new equity. New equity increases the total shares outstanding, which have a dilutive effect on the ownership percentage of existing shareholders. Management should avoid equity dilution at all times. To improve the liquidity, equity dilution is suitable sometimes; however, it should be only when the proportionate growth is visible.

Reasonable dividend

If the company is showing earnings of 100 & giving dividend equivalent of just ten or less, it raises more doubts on such companies before building conviction. There should be an acceptable dividend policy; however, if the profits are being used to improve the business quality further or for capacity expansion, fewer dividends may be sufficient.

Low PE

Lower the price-earnings multiple, better multiple returns potential in the future. With the growth in earnings & with every new milestone achievement, PE gets re-rated, and then there is usually a multiplier effect on the stock price.

Association with a brand

If the company has its growing reputation or is associated with some client who itself is a brand, that’s a big positive.

In conclusion, do remember that these are just a few aspects to spot a multibagger. Many stocks may not fit into any or all of these parameters. An example is Bajaj Finance, which has proven to be a massive compounder despite not checking many of the boxes like Debt, Environment risk, or having Low PE. It is essential to be flexible when looking at the fundamentals of the stock before investing in it. If you are a retail investor, keep some basic things in mind as follows:

1. Why you are investing – invest with a goal and plan.
2. Time frame – you may be better off in debt instruments or bonds for a short time frame.
3. Knowledge of the company/industries – stick to your circle of competence.
4. Risk and Reward ratio – Never invest without learning the risk associated with the particular investment.
5. Stock price is affected by market condition/Govt policy, so keep updated – especially true of highly regulated sectors.
6. Keep part profit booking/average – you can do this downwards or upwards.