Multibaggers as the name suggests the stocks which grows multiple number of times with respective to capital invested. Massive wealth creators like Warren Buffet, Rakesh Jhunjhunwala, Peter Lynch and others who have consistently beaten the markets have been banking on multibaggers for creating humongous amount of wealth.
Certainly, it is not easy to find such multibaggers. This article will guide investors in finding multibaggers.
How to Find Multibagger Stocks
Factors to Consider in finding Multibagger Stocks
There are 2 type of growth – Sales Growth and Profit Growth.
Sales is the total value of invoices generated by the company in a specified period.
Sales growth indicates the company is focusing taking orders and timely executing them. It also indicates that the sector has demand and economy is conducive to the demand.
Profit growth indicates that the company is not booking low- margin or negative margin orders for obtaining sales growth.
Further, profit is the ultimate goal of any business – More the profit, more the cash generated!
I will look for a company with sales and profit growth of over 20% year on year.
2. ROCE & ROE
ROCE or Return On Capital Employed is the ratio of earning before interest and tax (EBIT) to the total capital employed. ROE or Return On Equity is the ratio of net profit to the share holders equity.
Both of the above factors determine how efficient the company is using the capital.
I would prefer stocks with ROCE and ROE of greater than 25%.
Page Industries which is consistently giving an ROCE of 50% has become a 40 bagger since 2007.
3. P/E ratio
P/E or Price to earnings is the ratio of current market price to the trailing twelve month’s earnings (EPS).
It is the amount you are willing to pay per share for every Rs.1 gain in earnings.
To keep it simple, we would say it indicates how much the investors have faith in the company. Greater the P/E, more will be the investor confidence.
Since Share Price = P/E x EPS, the share price can grow in 2 ways –
a) Growth in EPS & b) Growth in P/E or growth in investor confidence.
Hence, most investors prefer shares with low P/E w.r.t. industry P/E.
We would prefer companies with P/E being less than 70% of the industry P/E.
4. D/E Ratio
D/E ratio or Debt to Equity ratio is the ratio of total liability to the shareholders fund.
It is the measure of a company’s financial leverage.
D/E ratio greater than one means the company has taken more debt than the cash from shareholders equity which is a wrong way to grow as it increases financial burden due to interests to be paid.
For D/E > 1, increase in D/E ratio year on year basis, indicates the company is not able to manage funds properly and is taking more debt to continue with its operations.
Ideally, we should focus on companies with D/E less than 0.7
5. Companies with Competitive Advantages or Relatively Small Businesses
Companies having competitive advantages have greater prospects of growth as they hold monopoly status in the market. Companies like Eicher Motors selling Royal Enfield and Page Industries owning all major inner garments brands in India are having command over their respective industry with hardly any competitor. Hence as the industry grows, so does the company.
In case there are competitors in the market, the smaller companies hold better growth prospects.
6. Free Cash Flow
This is the most important and the most ignored factor used while choosing stocks by small investors.
Free Cash flow (FCF) is the cash generated and realized by the company in a specified period.
Often profit which is seen in the P&L statement is not getting reflected seen in the cash flow statement.
This is because the company is not collecting cash efficiently or is having very stringent payment terms with the customers.
Or the companies have purposely tampered with the P&L statements to present a good picture of the company!
Periodically analysing FCF of the subject company will help in avoiding such risky company.
Interestingly, FCF is used for valuation of a company with Discounted Cash flow method.
There should be regular growth in FCF for finding multibaggers.