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What are the signals that a stock could be a multi-bagger?

22 Mar 2023

We all dream of identifying multi-bagger stocks during our lifetimes and see our wealth grow many times over. So, what is multibagger stocks?  How to identify multibagger stocks India and what are the key characteristics that set these stocks apart. The truth is that identifying multibagger stocks is actually not as difficult as it is made out to be. To begin with, there is a broad model that we can follow which helps us to identify such potential multibagger stocks. Here are some valuable tips on how to find multibagger stocks..

It is all about growth, growth, growth
Growth is the key word when it comes to identifying multibagger stocks. You cannot ever expect a high dividend yield stock or a stock in a stable industry with a high ROE to ever become a multibagger. A stock becomes a multibagger when it gets into the right line of business at the right time. As a result, the company is able to grow consistently for a very long period of time. Hero Moto in two-wheelers, Eicher in high-end bikes, Infosys in software, Sun Pharma in generics; are all classic examples of companies that could actually sustain high levels of growth for a very long period of time. That is the primary quality of a multibagger stock.

Is the model scalable in the true sense of the term?
The meaning of scalable is that there is a huge market potential waiting to be tapped. That means that you can actually produce on a mass scale and the economies of scale will help you to reduce your cost of production. Be it software or pharma or auto ancillaries; all these sectors could actually produce multi-baggers only because they could scale up their business models almost limitlessly. That ensured costs were under control and revenues were constantly growing.

What are the entry barriers that the business can create?
Some call it a moat, but the entry barrier essentially refers to some unique advantage that the company can create. This moat or entry barrier makes it difficult for others to replicate its business model. The moat could be scale, it could be a unique brand, it could be access to key markets etc. Companies like Sun Pharma, Hero Moto and Infosys could actually create these moats which explains why their performance sustained for such a long time. For example, large MNCs like Hindustan Unilever, Colgate and Britannia have created formidable brands that sets them apart.

Is the company avoiding debt like the plague?
A good wealth creator or a multibagger must necessarily be a low-debt company. In the last 10 years we have seen so many business groups like the ADAG group, Bhushan group, Amtek Group and Videocon group actually destroy shareholder value purely because they were hugely indebted. When you are deep in debt, then your financial risk imperils your balance sheet and makes any meaningful wealth creation impossible. Typically, if you look at any multibagger you will find that they are businesses that have growth on customer money with very low levels of debt. Low debt has always been a key feature of multibagger stocks.

Always be wary of a large equity base..
If a large debt burden is a strict "no", then so is a huge equity base. A large equity base means that a larger capital base has to be serviced. Remember, cost of equity is always higher than the cost of debt so a larger equity base not only depresses valuations but also reduces shareholder returns on a per share basis. Take the case of Tata Teleservices. The company had such a huge equity base that it could never earn enough on a per share basis to get any reasonable valuation. Lower equity base means higher ROE, higher EPS and consequently higher growth in earnings. This result in higher valuations!

What is the company's track record in meeting estimates?
What is it that sets a company like Infosys or a Motherson Sumi apart from the rest of the crowd? Performance, brand value, scalability, trust are all very critical. However, a lot more important than all that is the ability to consistently deliver performance that is better than your promise. That is what Infosys consistently did quarter after quarter. Over the past 20 years, Motherson Sumi has presented very aggressive targets for the next 5 years and on each occasion it has managed to better its estimates. That is the unique quality that multibagger stocks are made of.

Is the company actually behaving like a miser?
Miser has a negative connotation in popular parlance. But, when it comes to identifying multibagger stocks always prefer misers. Yes we are talking about companies that try to cut costs to the maximum extent possible. We are talking about companies that try to extract every penny of value out of the money that they spend. Value creation has never been a feature of the spendthrift corporates. Be it Apple in the US or Infosys in India, these companies have created genuine wealth by extracting every ounce of value possible out of each dollar spent.

As we said earlier, identifying a multibagger is not rocket science. There is a very basic and simple framework to follow. At the end of the day, the question is about holding period. As Warren Buffet summed it up, if you want a multibagger then your holding period could be "Forever".

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