How to Spot a 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.How to spot a multibagger 1How to spot a multibagger 2

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.

How to spot a multibagger 3Debt 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.How to spot a multibagger 4

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.

Asset Location Is As Important As Asset Allocation

The science of asset allocation gets a lot of attention in the personal finance realm, but it only tells part of the story. In an ideal world, there would be no taxes or transaction costs, so that asset allocation would be the only game in town. You’d simply divide your portfolio between the various asset classes and forget about it.

Rebalancing would be a non-issue because there would be no tax consequences, and you wouldn’t have to worry about which account is most suitable for your small-cap value fund. If you have all of your retirement savings in your 401K or an IRA substantially, you can get away with doing that. Unfortunately for the rest of us, Uncle Sam wants his cut.

Nobody Loves The IRS

Excepting congress, which needs enormous sums of tax dollars for important projects like building bridges to nowhere and llama farms for orphan llamas, nobody likes the IRS. I am no exception, and if you too share my raw hatred of the IRS, you would be wise to think long and hard about asset location.

Asset location is the art of placing different asset classes in various types of accounts, depending on a combination of the tax-efficiency of that asset class and the tax characteristics of the kind of account in question.

Here’s an example to make what I just said make sense.

Suppose you have a target asset allocation for your retirement portfolio of 50% stocks and 50% bonds. Furthermore, about half of that portfolio is in your 401K at work, and half is in either a regular taxable account or a Roth IRA. The best course of action would be to put the bonds in your 401K and stocks in your taxable account or Roth. The reason for this is that bond interest is taxed as regular income and stock dividends, and long-term capital gains are taxed at lower capital-gains rates. Since everything in your 401K will eventually be taxed at standard income tax rates when you liquidate, putting stocks in it would amount to intentionally paying more taxes than necessary.

In contrast, bond interest is taxed as income, so you lose nothing by putting them in your 401K. Proper asset location can make a huge difference in your long-term returns, so it’s well worth paying attention to.

Here is a list of asset classes and the optimal type of account they should be placed in, if possible.

Least tax-efficient

place in a tax-deferred account (401k, traditional IRA, etc.)

High-yield bonds
Taxable Bonds

Medium tax-efficiency

place in a tax-free account (Roth IRA, Roth 401k)

Balanced Funds
Small-cap stock funds
Actively-managed stock funds
Value stock funds
International Stock funds

Most tax-efficient

fine to place in a taxable account

Broadly diversified stock index funds
Tax-managed stock funds
I/EE savings bonds
Tax-exempt municipal bonds

ETFs: Your free guide to exchange-traded funds

An exchange-traded fund (ETF) is a security that tracks a particular index or basket of assets. This could be the FTSE 100 or a selection of shares of companies involved in alternative energy.

ETFs are traded on the stock market, just like ordinary shares. So they can be bought and sold whenever the market is open, at a regularly updated price. By contrast, passive unit trusts – a rival tracking product – can only be dealt with once a day and only through the issuing manager.

Even though ETFs trade like ordinary shares, they don’t attract stamp duty when they’re purchased.

Diversification and cost benefits

ETFs offer exposure to an entire index, usually at relatively low cost. They are not actively managed, which means there is no need to pay fat salaries to a fund manager. As a result, annual expenses paid by the ETF investor are relatively low, typically between 0.2 and 0.75 percent of funds invested.

What’s more, ETFs are not subject to an initial charge or set-up fee, as is the case with unit trusts. The only costs when dealing are the standard brokerage commission and the spread – the difference between the prices at which you can buy and sell.

What’s on offer?

Today, the range of ETFs on offer is wider than ever before, covering an ever-expanding array of national indices, industrial sectors, commodities, futures, bonds, and other asset classes.

Consequently, it is now much easier for private investors to gain exposure to a range of previously inaccessible markets. There are also opportunities to achieve double or treble returns, as well as to sell short.

Index and specialist ETFs

Besides mainstream ETFs that track the world’s top indices such as the FTSE 100 or the Dow Jones, you can also buy or short sell individual industries such as mining or financial services. So, if you were bullish on the stock market in general but bearish about miners, you could buy an index ETF while short selling a mining ETF.

As well as national stock markets such as China or Brazil, ETFs cover segments of the market, such as mid-sized or small companies, and also entire geographic regions such as Europe or Asia.

Away from equities, there are ETFs that track commodity indices, government and company debt, real estate, private equity, and currencies.

Profit when markets fall

Whereas unit trusts generally only benefit when the markets they track go up, there is a type of ETF that gains in value when their underlying market falls. Short ETFs provide a mirror image of whatever the price of the underlying asset does. So if oil falls, they rise.

However, in terms of the equity-linked indexes, these types of ETFs are only really suitable for sophisticated traders. This is because the price of the benchmark index is re-set daily, and the returns are compounded – so, even if the index is down over an extended period, an investor who held on through volatile trading conditions could still conceivably lose money even if he was right in his prediction of a fall in the underlying.

Exchange-traded commodities

Originally, the large size of commodity futures contracts prevented small investors from getting direct exposure to commodities. With the advent of exchange-traded commodities (ETCs), the minimum financial outlay has been markedly reduced, thereby easing the way for private investors.

ETCs track the performance of individual commodities such as copper, petroleum or wheat, or even total return indices based on a single commodity. For example, many investors have recently gained exposure to physical gold for the first time through the use of ETCs such as ETFS Physical Gold (code: PHAU), which has been designed to provide a return equivalent to movements in the gold spot price. Currently, around 70 percent of private investment is allocated to precious metals, while 15 percent is given over to energy ETCs.

If, however, you want to spread your risk, you could always opt for an ETF that invests in a more diversified basket of commodities, such as the ETFs All Commodities ETF (AIGC). This has been structured to track the DJ-AIG Commodity index.

Government and corporate bonds

ETFs have also made it much easier for private investors seeking to buy into the government and corporate bond market. As ETFs are traded on the stock exchange, both historic and real-time pricing must be made readily available. Such price transparency was once the preserve of institutional investors, so ETFs have done much to open up this market.

As most bonds are held till maturity, the main problem facing those structuring a bond ETF is ensuring that it is comprised of enough liquid bonds to track a particular index. (This is more of a problem for corporate as opposed to government bonds). For this reason, representative sampling is often employed, which involves reducing coverage of an ETF to the most liquid of the bonds, and is a feature of ETFs such as the iShares Euro Corporate Bond (IBCX), which offers exposure to a range of euro-denominated investment-grade corporate bonds.

Tracking issues

Tracking errors pertaining to the bulk of ETFs and ETNs currently in issue remain relatively small, according to recent research from Morgan Stanley. Despite extreme market volatility, these instruments demonstrated close alignment to most indexes. Last year, the weighted average tracking error for all US ETFs was just 0.39 percent.

This is not to say, however, that negative tracking errors do not occur. Some specialist ETFs, or those subject to diversification requirements, haven’t always fared well, and the process of representative sampling (referred to above) is another factor that can lead to tracking errors.

The Vanguard Telecom Services ETF (VOX) and the iShares FTSE NAREIT Mortgage REITs (REM) both fell short of their tracking indexes last year. Additionally, investors need to remember that ETFs with larger expense ratios tend to have higher tracking errors simply because fees come directly out of investors’ returns.

Interest and distribution payments

Bond ETFs pay out interest through a monthly distribution, while any capital gains are paid out on an annual basis, fewer fees, and expenses. Holders of share-backed ETFs are also eligible to receive payments in the form of a pro-rata share of dividends payable on the portfolio of stocks comprising a given ETF.

It may be possible in some instances to reinvest your dividend payments. Dividends paid out of an ETF’s net investment income or net short-term capital gains – if any – are both taxable as ordinary income. Distributions of net long-term capital gains, in excess of any net short-term capital losses, are taxable as long-term capital gains.

Tips on how to manage money when you get a raise

A raise can be a boon to your household finances. Although it is tempting to immediately spend the entire raise on a new car, handbag, laptop, or gadget, there are several considerations that should be addressed before you splurge.

The first thing you should do if you get a significant raise is checking your tax situation. There are some instances when the raise pushes your income into the next tax bracket. Most employers will automatically adjust your withholding, but if you are already claiming zero exemptions, you may need to have an additional amount withheld in order to avoid penalties. This will require an updated W-4 form.

The next thing to consider is your retirement contributions. If you have access to a 401(k) account from your employer and your employer offers matching funds, you should contribute at least enough to the account to receive the full company match. Even if your fund choices are meager, the employer match is free money that is available to fund your retirement. If your 401(k) offers low-cost mutual funds or index funds, consider increasing your contribution to the federal maximum. In 2009, the maximum annual contribution is $16,500 or $22,000 if you are over 50.

When considering a significant 401(k) contribution, keep in mind that every employer has slightly different limitations that may prevent you from contributing to the federal maximum. One limitation is the maximum percentage limit or the maximum percentage of your pay that you are allowed to contribute and shield from taxes. The second limitation is the highly compensated employee (HCE) income limit. Employees that have an annual income greater than the HCE limit will have their maximum contribution lowered or even reduced to $0.

If you do not have access to a 401(k) account or you are contributing the maximum amount, consider saving most or all of your raise in an IRA or a savings vehicle. The savings vehicle should be chosen based on your timeline. Money earmarked for an emergency fund should be liquid, either in a high-interest savings account or in a combination of savings and a short-term (under two years) CD ladder. Money designated for large expenses should be in a CD ladder with a timeline based on when you expect to incur the expenses.

Finally, if you are able to fully fund a 401(k) or another retirement account, an emergency fund, and a large expense fund, use some of your raise as a reward for your fiscal responsibility, but keep in mind that a permanent boost in your standard of living may put you at risk for living beyond your means in the future.