Types of Multibagger Stocks and How to Spot Them?
Investors always look for multibagger shares, that can give them superior returns in the long term. The problem most investors face while identifying multibaggers is that they do not know how to spot them.
Every multibagger stock has certain characteristics that make it a potential multibagger, such as consistent earnings growth, low debt, high profit margin, future growth potential etc.
I have already written a detailed post on “Characteristics of a Multibagger Stock”, which will help you understand the necessary traits a multibagger has.
While it is important to understand the characteristics of a multibagger stock, it is equally important to understand the types of multibagger stocks and how to spot them.
There are four reasons why a stock becomes a multibagger, because of its consistent earnings growth, second because it has potential to turnaround from loss making company to a profit making one, third because the company is small in size but has a dominant position in the market, and finally, because its highly undervalued compared to its net-worth or assets.
Let us now understand all the types of multibagger stocks, in detail with real life examples.
The first type in the types of multibagger stocks are consistent performers. These are the companies that show consistent earnings growth, command higher profit margin, and have very little competition.
These companies have established brand names, or a very unique product offering that is difficult to copy or replicate by competitors, this allows companies to grow their business while successfully keeping competition away from taking their market share.
How to Spot Them?
Consistent performers show consistent growth in EPS(Earning Per Share), while maintaining the profit margins, and have very little to no debt. While consistent EPS growth shows strong growth in Net Profit, high and stable profit margin demonstrate that company has strong pricing power on its products and services.
Companies with low debt shows that the business is self sustainable and does not require external funding from external sources to expand its business.
Example: Asian Paints.
Asian Paints is a strong brand name in decorative and protective paints segment with over 54% market share.
Company has variety of product offerings across various price segments.
Company has created a strong brand name which acts as a strong economic moat, allowing it to keep the competitors away from taking away its market share.
In the screenshot below, you can see how consistently, Asian Paints has increased its EPS in the past 5 years and has also improved its profit margins, while staying debt free all along.
Because of its strong and consistent growth, shares of Asian Paints have give more than 4x returns in the past 5 years, not to forget, consistent dividends each year as well.
Types of Multibagger Stocks #2. Turnaround Stories:
The second type of stock in out types of multibagger stocks is a turnaround story.
These are the companies the turn profitable after a long phase of making losses, that is, they turn around, and become profitable. This usually happens because of two major factors.
First, change in management or leadership.
Management of a company plays a crucial roles in the business and financial performance of the company.
A loss making company does not necessarily have poor business, sometimes an inefficient management may also be the reason.
Some companies do have a good business but suffer losses due to poor management.
A good management utilizes business resources efficiently, cuts cost of doing business and works towards achieving higher business growth.
When an old and inefficient management is replaced by new, more ambitious, and efficient management team, the business may turnaround very soon.
Second reason why companies become turnaround stories is support from macroeconomic factors, that is growth in the sector in which the company is working.
No matter how good the management of the company is, if the economic environment does not support the sector in which the company is working, it’s hard for even the best companies to stay profitable.
For example, few years back, due to poor Government policies(such as cancellation of coal mines allocation, etc), the macroeconomic environment for power producing companies and iron and steel companies was very bad.
Even the best and most efficiently managed companies were finding it difficult to survive.
As a result, many power producing companies went insolvent (such as Lanco Infra and power Ltd.)
How to Spot Them?
Turnaround stories are really hard to spot way in advance. Such turnarounds are usually seen in stocks or sectors that have been beaten down for many years.
You have to be vigilant towards structural changes in the management and the economy of a sector.
You have to keep tracking the Government policies and understand, which company will be the biggest beneficiary of such policy changes.
For the companies that turnaround based on the change in management, you have to keep an eye on the news related to management.
Another reliable source that may indicate turnaround is corporate filings by the company. You have to keep an eye on the changes taking place in top management such as change in Director, CEO or any other top management official, which may have significant impact on the way business decisions are made.
Secondly, an early sign of a turnaround story can be spotted in company’s improved quarterly numbers.
A recent example of turnaround story in types of multibagger stocks is HEG. HEG is a large cap company engaged in manufacturing of Carbon electrodes used in electric arc furnaces for producing steel.
When the entire power and steel sector was going through tough phase, HEG was struggling to remain profitable as there was a no capacity expansion, because of poor macroeconomics.
So what led to sudden turn around in the stock?
Few years back, China, which is a dominant player in steel production, started shutting down its steel mills to control rising pollution levels.
Since most of the Chinese steel manufacturing facilities use blast furnace method to produce steel, they had to shut down their old manufacturing facilities and shift to Electric Arc Furnace.
This led to huge spike in demand for Carbon electrodes, providing bothe price and volume to companies like HEG.
As a result, HEG turned around from a loss of Rs. 8.43 crore in June 2017 to a profit of Rs. 777.3 crores in June 2018.
As a result, the Stock, which was trading within a range for past many years, nit giving any fruitful returns, saw a huge rally in a short span of time.
Types of Multibagger Stocks #3. Niche Players:
The third variety in our types of multibagger stocks are the niche players. These companies are smaller in size but have leadership position in their sector.
Such companies are usually found in small size, but rapidly growing sectors, which may be a subset of a larger industry.
The biggest advantage of niche players is that their industry is small in size which does not allow many players to participate in it, making it less competitive.
Companies that successfully create a dominant position in such niche industries not only command better pricing power over others, but also enjoy almost a monopoly, which provides a sustainable growth for long term.
How to Spot them?
Niche players can be found in sub category of a larger industry, for which you have to divide a sector into many components that contribute to make it.
For example, An infrastructure development sector has many sub-components which includes, infrastructure developers, cement manufacturing companies, Iron and steel companies, real estate developers, interior infrastructure (such as plywood manufacturers, ceramic bath fittings, tile manufacturers, etc).
While some of these sub-categories are highly fragmented with many players competing each other to take maximum market share and revenue, there are some niches, smaller in size but have few players in the market.
An example of niche player in types of multibagger stocks is Kajaria Ceramics.
Example: Kajaria Ceramics
Kajaria Ceramics is the market leader in ceramic tiles segment with over 30% market share. The entire ceramic tiles market of India is valued at approx Rs.26,500 crores, and is growing by 9% annually.
Post GST, there has been a decline of import of ceramic tiles from China, providing a great opportunity to companies like Kajaria Ceramics to expand their market shares.
There are few domestic player in this segment (Somany Ceramics and Asian Granito).
Being in a small sized industry, there is little room for additional players to participate and grow easily.
This allows market leaders like Kajaria Ceramics a better pricing power and dominance in the market, providing long term competitive advantage needed to expand the business.
Types of Multibagger Stocks #4: Asset Plays
This is by far the most important types of multibagger stocks. Asset plays are mispriced stocks, that is they trade at significantly lower market price than their actual business worth.
These stocks have been favorite among value investors like Warren Buffett, Peter Lynch, as they provide huge margin of safety to their investment, one of the most important characteristics of value investing.
There are many reasons why a stock may be undervalued, including, small size of the company because of which, it is mostly overlooked by the investors.
A company may be undervalued because it is going through a tough phase, but will ultimately recover.
you must always remember, just because a stock is undervalued, does not make it a good investment.
A company may be undervalued because of its poor fundamentals and may not ever recover, leading to huge investment losses.
If you are looking for asset play multibaggers, you should be careful while picking the stocks, and should do a proper research and fundamental analysis before making an investment decision.
How to Spot Them?
There are many ways to spot an asset play. One of the most reliable way is to value the tangible assets of a company, and if the total value of all the assets is much higher than the total market value of the company, it is an asset play.
An important point you must remember is that the asset based valuation model is suitable for asset heavy businesses such as Power producers, Iron and Steel, Cement manufacturers etc. Companies with lot of intangible assets(especially service based companies like IT, E-Commerce etc), may not fit in this valuation model.
In order to value service based, asset light companies, you need to compare their cash reserves and their expected future cash flows, and value the business accordingly.
Example: Maharashtra Scooters
Maharashtra Scooters is one of the best examples of asset plays. Maharashtra Scooters was manufacturer of scooters back in early 80’s and 90’s under brand name “Priya”.
Post liberalization of the economy, many international players entered the two wheeler market and companies like Maharashtra Scooters lost their competitive advantage against them.
Recently, Bajaj Auto one of the leading automobile manufacturers of India, created a Joint Venture with Maharashtra Scooters, and turned it into a holding company.
Maharashtra Scooters now holds shares of Bajaj Auto and some other investment on behalf of Bajaj Group of companies.
What makes Maharashtra Scooter an asset play? Well, the total market capitalization of Maharashtra Scooters is Rs. 2,500 Crores (as on 11/10/2018), while the total Reserves and Surplus of the company (that is retained earnings from past profits) is equal to Rs. 8,213.84 crores.
Clearly, Maharashtra Scooters is currently way undervalued than its actual worth, making it a great case of an asset play.
Every market crash provides you a great opportunity to spot multibagger stocks, as most good quality stocks trade at a discount because of people’s panic.
However, if you have the right mindset, discipline and a long term vision, finding multibaggers in any market condition is not difficult.
Multibaggers are not created in a day or two, so you need to give them time and be patient, and wait for the market to realize the right value of the stock. It takes a lot of patience, but is worth the pain.
So that concludes our post on “Types of Multibagger Stocks and How to Spot Them”. I hope you found this post useful and enjoyable.