Saturday, 7 July 2012

How to pick Multi-Baggers

"To achieve satisfactory investment results is easier than most people realise; to achieve superior results is harder than it looks."
- Benjamin Graham

Here are the key lessons from a study:
■Bad businesses can never create a multi-bagger, though they can create transitory multi-baggers during short phases when the conditions are good.
■Bad managements with good businesses are likely to create only transitory gainers.
■Overpriced shares have no chance of becoming multi-baggers ever.

So the only way one can hope to find lasting multi-baggers is by buying into great businesses run by good managements purchased at huge margin of safety.

Why some multi-baggers destroy wealth eventually
Having said that, it is not that one could get rich for ever by buying multi-baggers. The study says there are two types of multi-baggers: 
  • Enduring multi-baggers and 
  • Transitory multi-baggers.
Enduring multi-baggers are those companies whose wealth creation is long-lasting and correction from the peak valuation is limited.
  • In fact, they continue to exist as multi-baggers even after the correction.
  • The enduring multi-bagging companies are typically few and difficult to be spotted, and 
  • most of the time they appear to be expensive at the time of buying because of the lack of faith in their longevity and size of growth.
Transitory multi-baggers, on the contrary, are easier to be spotted but they always end up giving nasty end results.
  • Corrections are typically almost 100 per cent. 
  • Cyclicals broadly come under this category. 
  • The tragedy with this class of companies is that if you cannot sell in time, nothing is left in your hand.
  • But as correction is inevitable, market as a whole is left high and dry with a bad experience. 
  • These companies are plenty and easy to be found, and they attract a lot of crowd.
The result reveals that most of the multi-baggers were transitory in nature during this period and they threw back all the wealth that had been created on their journey upwards.

What is the winning strategy?
"Stocks are simple. All you do is buy shares in a great business - with managers of the highest integrity and ability - for less than the business is intrinsically worth. Then you own those shares forever."
- Warren Buffet

In essence, weak managements will lead only to transitory gainers whereas good managements can shine only if business performance helps.

As per Warren Buffet: "With a few exceptions, when management with a reputation for brilliance tackles a business with a reputation for poor fundamentals, it is the reputation of the business that remains intact."

So it boils down to the fact that for the making of enduring multi-baggers, a good business with a good management is necessary.


"Have the purchase price be so attractive that even a mediocre sale gives attractive returns."
- Warren Buffet

One factor, which is absolutely important for making a multi-bagger, is gross under-valuation or huge margin of safety in price at the time of purchase.

Some of the pointers to under-valued stocks are one or more of the following:
■Low price in relation to asset value
■Low price in relation to earnings and cash flows
■Sustained purchase by insiders
■A significant decline in stock prices
■Small market capitalisation with growth

Also, the best time to get a huge margin of safety is when:
■Business conditions are unfavorable and near-term prospects look poor.
■When low prices of stocks reflect the current pessimism either in a particular stock or in the market as a whole.
■When a large company's performance is hit and the pessimism is fully reflected in the price.

Low P/E and P/B works because:
■The reinvested earnings are substantial in relation to the price paid. The effect of large earnings addition year after year keeps adding to the intrinsic strength of the stock and, hence, can't be ignored by the market for long.
■The bull market is typically very generous to low-priced issues and thus will raise the typical bargain issue to at least a reasonable level.
■There could be chances of smaller companies with high earnings being taken over by larger ones as a part of diversification programme.

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