Education & Insights: On the quest for multibaggers

My quest this week has been to identify companies with multi-bagger potential. It hasn’t been easy - the markets don’t appear to be bursting with growth opportunities right now. Multi-bagger hunting is much easier done in hindsight!

But while scanning the market for multi-baggers you might have missed can feel like a frustrating exercise, there are lessons to be learned which can help you in your quest for future high performers. Because, although multi-baggers can come from almost any sector and any market, there are identifiable traits which many of them share at the beginning of their journey.

Ed identified the shared traits of multibaggers in this study: Makings of a multibagger

Armed with this information I set about scouring global markets for future multi-baggers and found myself having to fight some natural instincts which have driven my quest for growth stocks in the past.

For example, I (begrudgingly) steered clear of the US tech sector. I love the tech sector and think many of the companies with high margins and a dominant market share could continue to generate impressive returns for their shareholders. But multi-bagger potential? I’m not so sure. That is because studies which have examined the stocks which end up multiplying many times, generating big rewards for their shareholders have identified two crucial characteristics: earnings growth and multiple expansion. For the latter to be achieved, companies need to have a sensible starting multiple. The US tech sector is full of high growth companies, but there are very few sensible multiples to be found.

I have also found myself fighting the urge to scour UK stocks which are powered by a great story. In previous hunts for ‘moonshot shares’ I have been drawn to the small cap drug discovery space, or innovative tech companies or businesses doing something exciting in the renewables market. If they aren’t profitable I have often tried to convince myself that profits aren’t key for high growth stocks - after all, Amazon wasn’t profitable. But deep down, I know that is not a sensible way to approach investing. Amazon (which actually was profitable at the operating level) was the exception to the rule. The rule which states that most multi-bagger stocks have earnings which are growing fast.

Now this leads onto another interesting point which was made by a subscriber earlier this week: one of the best places to look for multi-bagger stocks is among those which have already multi-bagged. Stocks with momentum are prone to continue on their upward trajectory until something derails that.

It is therefore important to continue to check the investment case and fight the psychological failing of attachment bias. If your multi-bagger starts to show signs of margin decay (like Fevertree) or a weakening moat (like Asos) it might be time to call time on your investment. But if the positive signs are all still there, there is no reason why the stock can’t multi-bag again.

So what is the ideal holding period for investors looking to pursue this style? Mark has attempted to answer that question in his article this week - he’s crunched the data from eight years of Stockopedia growth investing performance and found a good system for investors employing a strictly systematic approach - you can read that here. But there is more nuance required if you are a discretionary stock picker. Having the gumption to run your winners can help magnify the returns of a multi-bagger. But remember to cut your losers - if you’ve made the wrong call it’s better to sell before things get really bad.