Finding multibagger stocks is a sort of holy grail for anyone investing in stocks. Multibaggers are the growth stocks that see their stock prices rise many times over and can turn $1,000 into $10,000 or even $100,000. It only takes a few multibagger stocks to transform the returns of an entire investment portfolio.
In this post we look at what it takes for a company’s stock price to appreciate more than 500%. We discuss some of the characteristics of multibagger stocks, examples of popular growth stocks and how to go about investing in them.
- What are multibagger stocks?
- How to identify a potential multibagger stock?
- Best industries and sectors to find multibagger stocks
- Rules to follow when investing in potential multibagger stocks
- Examples of popular stocks that have appreciated multiple times
- Risk management when investing in potential multibagger stocks
What are multibagger stocks?
If you buy a stock for $1 and sell it when the stock price reaches $11, your profit is equal to 1,000% or 10 times your initial investment. This makes it a 10-bagger. In practice a stock that reaches 10 times its purchase price would be referred to as a 10-bagger, although strictly speaking the profit is slightly less than 1,000%. Multibagger stocks are those that generate returns of 100% or more. A 2-bagger would give you a 100% return, while a 5-bagger would give you a 500% return. The term 10-bagger was coined by Peter Lynch, a legend of the mutual funds industry in the 1980s. He used the term to refer to stocks that returned 10 times their price in his book “One Up on Wall Street”.
Typically, multibagger stocks are growth stocks. If a stock is undervalued or has a good dividend yield it may well return 100 or 200% over a few years. But for a stock price to multiply again and again, the company needs to grow its profits. For the most part that means sales need to increase exponentially over time.
Some stocks (and other assets) appreciate a few times over during a bubble based entirely on speculation. But for a stock to achieve long term multibagger status, earnings and revenue must have a high growth rate for a sustained period of time. Earnings growth can quickly add up the way compound interest does, except that with earnings growth the numbers are typically higher.
The art of stock picking for potential multibagger stocks has more in common with startup investing than traditional stock market investing. The usual stock valuation metrics are of little use, while vision is required. There is typically a lot of uncertainty and risk associated with investing in these growth stocks.
How to identify a potential multibagger stock?
Ultimately, earnings growth is what creates multibagger returns. But, it’s not historical earnings growth that counts. Rather it is future earnings growth that counts. This means the potential for future growth is more important than historical growth rates. It’s very seldom that you will be able to identify a potential multibagger stock by conducting traditional analysis and looking at the company’s financial statements alone. More important are the company’s capabilities, the product, and the market.
To earn triple digit returns on a stock, you may have to invest before the company is even profitable. In fact, growing companies will often sell new equity stock to fund growth, rather than trying to keep expenses below revenue. For this reason, revenue growth is probably more important than earnings growth. However, you also need to be confident that profitability and earnings growth are on the horizon.
Multibagger stocks seldom look like a sure thing. Very often the companies are controversial in some way. Often there will be a large element of uncertainty. Some market analysts may question the business model and predict failure.
Characteristics of multibagger stocks
Growth stocks that go on to generate remarkably high returns typically share a few, if not all, of the following characteristics:
- A large potential market – The surest way for a company to become really big is to dominate a market early and then for the size of that market to multiply many times over. Both Amazon and Google managed to become market leaders just before their niches became really big markets.
- A wide moat – If a company has a wide moat it has something unique which prevents competitors from taking market share. This will allow the company to maintain market share and healthy profit margins while the market grows.
- Product market fit – If a product is a good fit for a market, customers will quickly see the value in the product, and it will be easy to sell. If there is good product market fit, other challenges can usually be overcome. If there isn’t, there’s a good chance that a competitor will eventually come up with a better solution.
- Strong “go to market” strategy – For rapid growth to occur a company needs the right distribution strategy and adequate funding. If it benefits from network effects this can also accelerate the growth.
- Visionary leader – Companies that grow rapidly often have visionary leaders who can keep employees and investors motivated during challenging periods.
- Asset light – There was a time when capital intensive businesses like railways and mines generated multibagger returns. These days, many of the best growth stocks own few assets. This means their operating margin expands as the business grows. It also means that cashflows don’t need to be reinvested.
Best industries and sectors to find multibagger stocks
Finding future multibaggers isn’t easy to do with precision. But you can improve your odds by looking at the right industries. Historically, most sectors have been through growth phases and produced multibagger stocks. Over the past two decades most growth stocks have been in the tech and consumer goods and services sectors. Over the next decade, it’s more likely that tenbaggers will also be in these sectors, though there may be a few exceptions.
The following industries are now best positioned to produce multibaggers:
- Software as a Service (SaaS) – SaaS companies provide cloud-based software solutions. This industry has a lot in its favor at the moment. Software is becoming more and more ubiquitous in every area of the economy. SaaS companies allow businesses and consumers to subscribe to a software platform rather than buying the software upfront. This is a compelling proposition and increases user numbers.
- Media and social media – The media industry is undergoing a complete transformation. Many thought that Facebook and Twitter would dominate social media forever. In reality the social media landscape is constantly evolving, and any platform that can grow its user base and user engagement has the potential to be a multibagger. The same applies to streaming services as the market continues to grow.
- New technology frontiers – Artificial intelligence (AI), Internet of things (IoT), virtual and augmented reality, and 5G technologies are four of the major technologies of the future. Traction for these technologies has been slower than expected and growth is not always visible. However, when these technologies become common place in consumer facing products, the profits will follow.
- Biotech – The Biotech industry is famous for creating the occasional multibagger, along with numerous failed companies. The outcomes for this industry are perhaps more binary than for any other. Substantial investment needs to be made to research and formulate a drug before conducting clinical trials and seeking regulatory board approval. At this point shareholders either earn a huge windfall, or as is often the case they are left with very little. No doubt the biotech industry will continue creating multibaggers – but specialist knowledge will be required to pick them.
- Health – In many ways the health industry has been slow to disrupt. However, major tech companies see the health industry as the next frontier. The health industry is plagued by high costs and a lot of inefficiency. This implies there are opportunities for innovative products to create multibagger returns.
- Fintech – Fintech companies are attempting to use technology to disrupt the financial services sector – an industry that has also been slow to evolve. Barriers to entry are high, but the potential rewards are considerable. Companies like Visa and Mastercard have already created substantial wealth for shareholders. Over the next decade it’s likely that several multibaggers will come from this industry.
Rules to follow when investing in high growth stocks
If you want to invest in multibagger stocks, there are three things to keep in mind. Firstly, it’s all but impossible to predict whether or not a stock will be a multibagger. Secondly, some of the stocks that you hope will become multibaggers will fail and may even go bankrupt.
And finally, successful multibaggers will probably still experience large drawdowns. When selecting stocks, you should decide on the companies that are worth risking capital on, and then invest in those stocks in a way that minimizes overall risk. The following principles can be applied to investing in high growth stocks:
- You will need to invest in a basket of potential multibaggers if you hope to end up with two or three successful picks.
- Your initial investment in each company should be very small. That way, the failure of one or more investments won’t affect the entire portfolio. Your successful picks will still go on to be large positions in your portfolio.
- Traditional fundamental analysis is unlikely to uncover a company’s potential to become a multibagger. Very often, you will have to pay a price that appears expensive according to standard stock valuation metrics. One of the most common investing myths is that cheap stocks generate the best returns. High prices should not put you off and you will sometimes need to pay a premium to own multibagger stocks.
- The fact that you may have to pay a premium doesn’t imply the stock price won’t fall – and it may fall a lot. If there is a market crash or the company faces a challenging period, the price could fall by anywhere from 50 to 90%. If this happens and you still believe in the company, you should add to your position. Averaging down on losers isn’t usually a good idea – but in this case the risk is lower, and the upside is greater.
The time frame for this sort of investing is long term – at least five years, but probably quite a lot longer. This means you shouldn’t pay too much attention to what happens in the short term. It also means that market timing is of less importance than deciding what to own. Large cap stocks can go on to appreciate by many multiples of their purchase price, but it is a lot easier for a smaller company to do that. You can also using some of the lessons of behavioral finance to take advantage of crowd psychology. The best time to buy potential multibaggers is when the market has become fixated on short term challenges.
Examples of popular stocks that have appreciated multiple times
The following are a few examples of multibagger stocks that illustrate some of the typical characteristics of growth stocks with potential to generate 500% plus returns.
- Tesla – There were several opportunities to buy Tesla before 2013 for $25. With the stock currently trading around $980, Tesla is a 38-bagger with an average return of 545% a year. Tesla has many of the qualities that make for multibaggers – a visionary leader, controversy, predictions of failure, and good product market fit.
- Netflix – The world’s first major video streaming company has also been one of the most successful growth stocks of the last two decades. If you bought the stock between 2003 and 2005 you would have paid around $2.50. It’s now trading at around 177 times that number, a return of over 17,000%. However, to achieve that return you would have had to endure drawdowns of 63%, 77% and 82%.
- Coca-Cola – The Coca Cola Company isn’t often thought of as a growth company, but it does prove how steady returns over a long period of time can add up. If you bought the stock in 1982 when it was trading at $1 and still owned it, you would be sitting on a 4,700% return, making it a 47-bagger. Thanks to the power of compounding, an average annual return of 11%, results in a compounded average return of 126% a year.
- Facebook – If you managed to buy Facebook for $40 or less in 2013, you would be sitting on a 487% return, making it not quite a 5-bagger. That’s not a bad return over a period of seven years but there have been plenty of better performers. Unfortunately for most investors, the really big returns were made by private investors before Facebook went public. The reason we include Facebook in this list is because it is a great example of product market fit and a good go to market strategy. There were other social media platforms around when Facebook launched, but it had the right product and strategy for growth.
- Tencent – If you bought Tencent on the Hong Kong Stock Exchange anytime between 2005 and March 2009 and held onto your position until the beginning of 2020, your investment will have multiplied somewhere between 35 and 220 times. This is a company that most people hadn’t heard of until a few years ago. It proves how important a big market is to a company’s success. In China most foreign social media platforms are blocked. This gave companies like Tencent exclusive access to China’s population of 1.3 billion at the same time that smartphones were becoming commonplace.
Risk management when investing in high growth stocks
Risk management for multibagger stocks is somewhat different than it is for other types of investing. It also needs to be considered at a stock specific level and in terms of portfolio risk.
At the individual stock level, your positions need to be small so that you can own enough different stocks to give you a good chance of owning a few big winners. These stocks will often be quite volatile, so small positions will reduce volatility for the entire portfolio. You can keep an eye out for typical warning signs for the stocks you own, but you also need to be prepared for surprises. The only way to do that is to keep positions small.
The percentage of your entire portfolio that you allocate to growth stocks will have a large impact on the volatility of the portfolio. Your high growth stocks shouldn’t account for more than 10 to 20% of the entire portfolio unless you have substantial risk appetite.
To reduce volatility, you will have to increase the allocation to other investment strategies and asset classes. Effective asset allocation will compensate for the higher volatility in your basket of growth stocks. ETF investing is an efficient and cost-effective way to construct the remainder of your portfolio with low volatility funds.
Conclusion: Try to visualize the future and companies that are likely to dominate
Growth investing is riskier than other types of investing, but also offers the greatest potential returns. One of the best ways to analyze and invest in growth stocks is by considering their potential to become multibagger stocks. This requires the ability to visualize the future, and the companies that are likely to dominate industries that are still in their infancy today.
Thanks Richard for writing this article. It is super easy to digest and apply.