Last week was multi-bagger week on Stockopedia. Ed presented the findings of the ongoing Stockopedia research project to identify the characteristics of the stocks that do exceptionally well. In my weekly article, I introduced the quality metric, Gross Profits to Assets and described how investors can use this to screen for potential high-return investments.
Ed's empirical research, based on the highest-performing UK stocks of the last decade, led him to conclude that multi-bagger stocks have the following characteristics:
- High StockRank
- Small Size
- High ROCE
- Low debt
- Moderate P/E
- Strong Trailing Sales Growth
- Outperforming the market over the last year
- Low share dilution
Thankfully, these correlate very well with my own multi-bagger framework, developed from the 100-baggers book and by following Warren Buffett and Charlie Munger:
- Moat;
- Runway;
- Operational Leverage; and
- Cheap.
I view each element of my multi-bagger framework like a lever. The best returns come from companies that can pull strongly on several of them, ideally all. A large runway allows rapid sales growth, while a moat means growth can be funded without dilution. Operational leverage enables earnings to grow more rapidly than sales, and the same is true for earnings per share due to the lack of dilution. Finally, if the multiple that the market is willing to pay for earnings expands, this further enhances returns.
The maths of multi-baggers
Mathematically, each part has the same impact:
Share Price Increase = Increase in Sales x Increase in Net Margin x Increase in Multiple / Increase in Number of Shares
Here's an example of how this works. Say a company has Sales of £20m and a net margin of 5%. This gives them £1m PAT. With, say, 100m shares in issue, they would have 1p EPS. If the market valued them at 10x earnings, they would be trading at 10p per share.
Fast forward ten years, sales have grown to £100m, and they have a net margin of 10%, then their PAT would be £10m. If the market now ascribed them a 20x P/E and the shares count had doubled to 200m, the share price would be 100p. Investors would have made ten times their money.
Share Price Increase = 5 x 2 x 2 / 2 = 10
The list of multi-baggers
Ed's seminar focussed on the highest performing ten stocks that started with a market cap greater than £50m. However, he also shared a longer list of stocks that had been high performers…
