What are Multibagger Stocks?

Stocks that generate more than 100% returns are called multibaggers. Many of these stocks are undervalued but have solid fundamentals. In many cases, multibagger stocks have solid financials and good corporate governance.

Moreover, their businesses are generally scalable within a short time. Peter Lynch, an American investor and mutual fund manager, coined the term ‘Multibagger’. It is an equity share that gives more than 100% return. They are usually present in emerging markets and fast-growing industries. 

Multibagger stocks are not a separate category of stocks but shares of companies with the potential to grow and earn profits compared to other firms. 

Multibagger stocks can generate wealth over time. In a growing economy such as India, people find many opportunities to pick multibagger stocks. However, you must check the fundamentals of the companies, or you will lose money if you pick the wrong stocks. 

How can you identify multibagger stocks?

• You must pick stocks of companies with low debt levels on their balance sheet. Otherwise, the company will struggle to service the interest on loans if it has huge short term and long term debts. 
• Check the business model of the company to determine how it makes money. You must look out for businesses which are relevant even after decades. 
• Look for companies whose earnings grow at a high rate consistently. For instance, companies that have regularly compounded their earnings at a high ROCE (Return on Capital Employed) can become multibaggers.  
• You must look for smaller companies with an economic moat. It is a competitive advantage a company enjoys over its competitors, which translates into a higher market share over time. 
• You must pick companies that consistently generate cash from operations. It helps the company grow fast every year and eventually become a multibagger. 
• Check the track record of the top management of the company. Businesses with skilled management and good corporate governance grow rapidly over time. 
• You must look for companies with strong promoter holdings. If the promoter believes in the business and maintains a higher stake, chances are the business will do well over time. 
• You need immense patience when it comes to multibagger stocks. For instance, it could take five or more years for a company to become a multibagger. 

What are the characteristics of multibagger stocks?

Multibagger stocks have two main characteristics:

1. Qualitative Characteristics
2. Quantitative Characteristics

Qualitative characteristics show how well the management runs the company. Moreover, you must study if the company has a competitive advantage over peers and rivals. For example, does the company offer a unique product or service? Do people trust the brand, and would they pay a higher price for it?

You must check the business goals set by the company and its track record of achieving them. For example, if a company states that it will grow exponentially in the future but doesn’t present a plan of action, you have cause to question this statement. However, if the company states that it will grow at 15% in the next five years and presents a plan of action to achieve this target, you can trust the management of the company. 

If you are looking for multibagger stocks, you must check how the company allocates its financial resources. For instance, businesses with conservative management generate a lot of free cash flow. Moreover, the company uses the free cash flow to fund growth and expansion or pay dividends to its shareholders.

Quantitative characteristics focus on the financial performance of a company. You must check if the company has high earnings growth. For instance, you must pick companies with high EPS (Earnings Per Share). It shows how much a company earns per share, and a higher EPS usually means a financially healthy company.  

You must check the Net Profit Margin of the company by dividing the Net Profit by the Net Sales. Multibagger stocks have higher Net Profit Margins as they may face little competition allowing them to charge higher prices for their products. 

It helps to check the future growth potential of the company. For instance, does the company focus on organic growth or inorganic growth. If a company invests its capital in creating assets and growing the business, it is organic growth. However, if a company focuses on acquisition and takeovers, it is inorganic growth. You must look at companies that focus on inorganic growth as they grow faster than other companies and have the potential to become multibaggers over time. 

Conclusion:

Multibagger stocks, by definition, are stocks that can rise exponentially in value. However, it can be a task to identify them. Look for companies that dominate their segment and focus on takeovers and acquisitions. Avoid companies that don’t focus on their core business, and look at firms which manage working capital efficiently.

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