During
last decade post global financial crisis of 2009, there are numerous companies
which have multiplied investor’s capital delivering super-duper multibagger
returns. Similarly, there are plenty of companies which have destroyed
investor’s capital to almost zero over last 10 years.
During
these days, when there is nervousness and panic across street and most of the retail
investors are bearing lot of pain in their equity portfolio, Sensex &
Nifty are further sprinkling salt on their burns by hitting new highs fuelled
by only a handful of index heavyweights. In fact, many retail investors who
entered in equity market during 2016 - 2017 are in dilemma to
know whether the stocks in their portfolio are good long term investment
candidates or the dud stocks.
Hence,
its important to know the basic criteria’s which make a company a right investment candidate with potential to multiply wealth in long term. Below are the 6 basic rules which we must follow to pick right companies having multibagger potential.
1. Quality management
with high integrity
Alignment of management interest with minority shareholders is one
of the key parameter. High standard of corporate governance ensures that
company is not involved in any wrong doings. Proper and timely disclosures of
shareholder related information by the companies build trust over time. Past
track record of promoters, disclosures and dividend pay-out history can help us
to check on this crucial parameter.
If the management is not honest, will they want to share the goodies with you? No, they will look for the first opportunity to siphon off the profits and pull the wool over your eyes. We have seen how the investors of LEEL Electricals have lost 95% of their capital over last 1 year due to personal enrichment of LEEL promoters by siphoning off company's profit from the sale of its consumer durable division to Havells.
2. High ROE &
ROCE – Efficient use of capital
Return on Equity (ROE) measures a company's profitability by comparing its net income to shareholders
equity (book value). ROE is a speed limit on self-funded growth (company's
profit). That is, a company cant grow earnings faster than its ROE without
raising cash by borrowing or selling more shares. For instance, a 15% ROE means
that the company can’t grow earnings faster than 15% annually by relying only
on profit to fuel growth. ROCE measures the overall returns for all
stakeholders and is a relatively good measure of the overall efficiency of the
company. A consistently low ROCE signifies that there is something inherently
wrong with the business or the company.
Wealth
creator stocks usually have very high ROE and the ROCE relative to the rest of
the industry. Typically, companies with high ROCE and ROE would also be
generating positive free cash flows consistently. Increasing ROE
and ROCE every passing year with low / negligible debt on books is one of the
key aspect in spotting multibagger stocks.
3. Low Debt and Free
Cash Flows
Its important to
learn the lesson from financial crisis of 2011 and now of 2019 that companies with high debt simply get slaughtered. While debt is not bad in
case if the company is able to borrow at a lower rate and deploy it in its
business at a higher rate as the operating leverage works in its favour,
however excessive debt with high interest and repayment obligations can crunch
the stock in times of downturn. So, as a long-term investment philosophy, it is
best to steer clear of high-debt companies.
Recent episode of
stock prices falling liking nine pins of ADAG companies (Reliance Power, Reliance Infra, Reliance Com, Reliance Capital), Essel group companies,
Jain Irrigation etc indicates how unbearable high debt burden on books can
destroy investors wealth in shortest span of time.
4. Asset Light
Business Model - No High Capex Requirements
We
know the demerits of investing in stocks like Suzlon & GMR Infra which have
an insatiable appetite for more and more capital. To feed their perennial
hunger, these companies dilute their equity by making FPOs, GDRs &
FCCBs resulting in total destruction of shareholders wealth. This is the
simple reason why we do not see multi-bagger opportunities from sectors like
metals, infrastructure and utilities because of the capital intensive business
model which leads to very high leverage and low return ratios.
Companies should be
lean and mean requiring minimal capital but generating huge returns with free cash flows which can be used not only to reward shareholders but also to expand
business in future. It is not necessary
that company should be a zero-debt company as some amount of leverage can
actually improve shareholders returns.
5. The Scale of
Opportunity & Non-cyclical Business
Multi-bagger stocks
are created because they are able to scale the opportunity rapidly. Titan Industries is a great example. In 2003-04, Titan was a small company with market capital of 500 crores.
As on date, its a large cap with more than 1 lakh crores market cap. The fact that
India is a booming marketplace of 132 crores consumers means that most products
and services have a head start at trying to scale up their activities.
One
key factor that creates value in the stock market is consistent growth across
economic & market cycles. While markets values growth, it also pay
higher premium on consistency in growth. Most of multi-baggers of past like
Asian Paints, Titan, Page Industries, United Spirits, Marico, Aurobindo Pharma are typically high
growth companies in non-cyclical businesses. It is extremely rare to find a
multi-bagger in a typical commodity business like steel, aluminium or oil.
6. Valuations
& Future Growth Prospects
Most investors are
obsessed about valuations, refusing to buy any stock that is expensive.
However, one must remember that expensive is a relative term. If a stock is
compounding at 25% on an annual basis, paying a price to earning multiple (P/E ratio) of 30 may
be very reasonable. A stock like Nestle or HUL, for instance, has always been
expensive. However, a great company with an impeccable pedigree may not
always be a good stock to buy. This could be due to the fact that most of the
triggers are already in the price and future growth potential does not justify
the valuations. The PEG ratio (which is PE ratio divided by sustainable growth)
is a simple way to measure valuation relative to growth.
But
it is equally important to consider other parameters like financial ratios and
brands that the company has created which can go a long way in determining
potential valuation. A particular company may look expensive to an investor who
have a 2 years horizon but may be a screaming buy for investor who wish to hold
it for next 5 to 7 years.
There is no guarantee that the above mentioned parameters would always help
investors identify multi-baggers, but these parameters will surely help investors to invest in right set of companies and avoiding those which may end up being value destructors. Moreover, we can learn by following key traits of successful investors who have created enormous wealth in past.
Making Money by Investing in Fast Growth Stocks
“The investor of today does not profit from yesterday’s growth.” Warren Buffett
Most of us have relatives who like to fashion themselves as ‘stock-gurus’, with their stories revolving around how they ‘could have been’ millionaires now, if only they had held their nerves. The stock that comes up frequently in these conversations is Infosys. If you had invested Rs. 9,500 to buy 100 shares of Infosys in the IPO (that went undersubscribed in 1993), 1,02,400 shares (adjusted for bonus issues) worth sum of Rs. 6,72,56,320 would be in your kitty.
Infy has given
CAGR returns of whopping 42.6% to investors during last 25 years (that too after keeping dividend payouts aside). Infosys got listed in June 1993 at price of Rs. 145 per share and investment of Rs. 9,500 in June 1993 is valued at ~6.73 crores today. But, is Infosys still the key to riches? As often repeated, past performance is no guarantee of future results. So, how does one find out the next ‘Infy’?
A Fast Grower is a small yet aggressive & nimble firm, which grows roughly at 20-25% a year. This is an investment category which can give investors a return of 10 to as much as 200 times the investment made by them. No doubt, it remains a favourite of
Peter Lynch!
In 1950s, the Utility & Power Sector were the fast growers with twice the growth rates to that of the US GDP. As people got more power-hungry gadgets for themselves, the power bills ran through the roof & the power sector surged with booming demand. Post the Oil Shock in 70’s, cost of power generation became high with power tariffs going up; people learnt to conserve electricity. Demand, thus, fell and power sector witnessed a slowdown. Prior to it, similar decline was observed in the Steel Sector & Railroads. First, it was the Automobile Sector, and then the Steel, followed by Chemicals & Power Utility & now the IT Sector is showing signs of slowing down. Every time, people thought, rally in the fast growers of the age would never end, but it did end, with people losing money as well as their jobs. Those who thought differently like Walter Chrysler (founder of Chrysler Corporation), who took a pay cut and left the railroads to build new cars in the turn of the last century, became the next millionaires.
Three phases involved in their life cycles, are:
1. The Start-Up Phase: Majority of the companies either burn up all the cash or run out of ideas by the end of this phase. Maximum casualties have been observed here, making it one of the riskiest phases. However, maximum returns can be made from them, if one enters near the end of this phase.
2. Rapid Expansion Phase: The Company’s core proposition has worked now, with the strategy being replicated by expansion of product/service portfolio or consumer touch points.
3. Mature Phase: Growth slows down, either due to high debt or low cash, owing to the massive expansion witnessed in early stage. Fall in demand or legal restrictions might also contribute to faltering growth.
The trick is to track, which phase the organization is in, at the moment. If the firm is in late start-up phase with possibility of moving to rapid expansion phase, buy the stock when it is still cheap. Once firm’s earnings start falling with its products witnessing poor demand, it’s time to bid goodbye to the stock.
The key parameters involved in
Peter Lynch’s ‘two minute drill’ are:
1. P/E Ratio: avoid stocks with excessively high P/E
5. Inventory levels: lower the better
Stay away from companies which are being actively tracked, followed & invested in by large institutional investors. News about buy back of shares or internal stakeholders increasing their stakes should be construed as positive.
Checks specific to Fast Growers:
1. The star product forms a majority of the company’s business.
2. Company’s success in more than one places to prove that expansion will work.
3. Still opportunity for penetration.
4. Stock is selling at its P/E ratio or near the growth rate.
5. Expansion is speeding up Or stable
One must judiciously walk the tightrope between the unquestioning belief that made the stock to be held for so long and the fear of the end from nose-diving prices due to a one-off bad year. The key is to always keep revisiting the story & ask some pertinent questions like ‘What would really keep them growing?’, ‘What is their next offering? or ‘Are their products & services still in vogue?’ It is here, that one must track the point of time when the phase 2 of the firm’s expansion comes to an end. This is usually the dead-end for organizations as success is difficult to be replicated. Unless, innovation happens, downfall is imminent & thus, an exit is necessary.
P/E of these stocks is drummed up to unrealistically high levels by the madness of crowd towards the end. One must keep one’s eyes & ears open to signs, which mark the end of the road for these fast growers. A great case in point is Polaroid which had its P/E bid up to 50, only to be rendered obsolete later by new technologies.
A sure shot sign of a decline is a company which is everywhere! Such a company would simply find no place to expand any further. Sooner, rather than later, such a company would see its ‘Manhattans’ of earnings reduced to ‘plateaus’ of little or no growth, simply because no space is left to expand further.
1.The quarterly sales decline for existing stores.
2. New stores opening, though results are disappointing: weakening demand, over supply.
3. High level of attrition at the top level.
4. Company pitching heavily to institutional investors talking about what Peter Lynch calls ‘diversification’.
5. Stock trading at a P/E of 30 or more, when most optimistic estimates of earning growth are lower than 15-20%, thus, unable to justify the high price.
Fast Growers, which pay, are ephemeral & one misses them more often than not. It is a High Risk & High Gain Category of Stocks. One must remember along the classic risk & return principle, that when one loses, one loses big! So, if you are in the quest for magnificent returns, a Fast Grower can be your bet provided you know when to bid Goodbye!
Power of Investing in Equity Market
Now, Just Imagine...
How much can you make in 39 years by just investing Rs.10,000 initially in any of financial instruments?
Take a wild guess? Let us look at the real example.
If you have subscribed for 100 shares of "X" company with a face value of Rs. 100 in 1980.
• In 1981 company declared 1:1 bonus = you have 200 shares
• In 1985 company declared 1:1 bonus = you have 400 shares
• In 1986 company split the share to Rs. 10 = you have 4,000 shares
• In 1987 company declared 1:1 bonus = you have 8,000 shares
• In 1989 company declared 1:1 bonus = you have 16,000 shares
• In 1992 company declared 1:1 bonus = you have 32,000 shares
• In 1995 company declared 1:1 bonus = you have 64,000 shares
• In 1997 company declared 1:2 bonus = you have 1,92,000 shares
• In 1999 company split the share to Rs. 2 = you have 9,60,000 shares
• In 2004 company declared 1:2 bonus = you have 28,80,000 shares
• In 2005 company declared 1:1 bonus = you have 57,60,000 shares
• In 2010 company declared 3:2 bonus = you have 96,00,000 shares
• In 2017 company declared 1:1 bonus = you have 1,92,00,000 shares• In 2019 company declared 3:1 bonus = you have 2,56,00,000 shares
Today, you have whopping 25.6 million shares of the company.
Any guess about the company? (Hint: It’s an Indian IT Company)
Any guess about the present valuation of Rs. 10,000 invested in 1980?
The company which has made fortune of millions is "WIPRO" with present valuation of ~740 crores (excluding dividend payments) for Rs. 10,000 invested in 1980.
Unbelievable, isn’t it? But it’s a Fact! Investing in companies with good fundamentals and proven track record can give far superior returns compared to any other asset class (real estate, precious metals, bonds etc) in a long run.
Will Wipro provide similar returns in next 38 years? Probably not, it’s already an IT giant. You need to explore companies in small and mid cap space with good track record and stay invested to create wealth in a long term.
Let's take another example of little known company - Mayur Uniquoters.
Mayur Uniquoters which we recommended 7 years back is a 5-Bagger stock for our Hidden Gems members. We recommended Buy on Mayur Uniquoter on 31 March 2012 at price of Rs. 56 (adjusted price after 2 bonus issues and stock split in last 7 years, actual recommended price was Rs. 448) and today closed at Rs. 280 giving absolute returns of 400%. In spite of fall in stock price by 40% from its 52 week high, Mayur Uniquoters is still a 5-Bagger stock in 7 years.
However, we missed to buy Mayur Uniquoters early. You might be surprised to know that Mayur Uniquoter is a 93-Bagger stock for investors who invested in it 10 years back. Investment of Rs. 1 lakh in Mayur Uniquoters in Jan 2009 is valued at more than Rs. 93 lakhs today. Mind boggling, isn't it? Company has posted strong growth YoY and rewarded share holders in big way, Mayur Uniquoters was trading at Rs. 3 (bonus issues and split adjusted price) with market cap of merely 13 crores in Jan 2009, today market cap of the company is 1,280 crores.
Mayur Uniquoters is still a great value stock considering its consistent performance and leadership position in artificial leather industry and robust demand for its products by esteemed clients from auto and footwear industry.
It is a garden out there and one need to simply provide sufficient time to grow his quality seeds to get the fruits. One has to know what he is doing and has to be cognizant about it. With a little research and patience stock market investments can yield maximum returns.
Do you own such stocks which can give you similar returns in future?
The number of small-cap stocks is large and finding a quality stock that can give high returns over a long period is tough even for equity analysts. One reason is that such stocks usually have a short history and are not tracked by many analysts and brokerage houses. Then there are risks such as low liquidity, governance concerns and competition from larger players.
Scores of once small companies have over the years grown big, giving investors a 30-50 percent annual return over 10-15 years and creating fortunes for investors. However, more often than not, we find ourselves at the wrong side of the fence and regret our inability to spot such stocks on time.
Buying Strategy for Small Caps
1. Go for companies with low debt ratio (preferably less than one)
2. A high interest coverage ratio (above 3x) and a high return on equity are big advantages
3. Avoid companies with huge liabilities in the form of foreign currency convertible bonds / external commercial borrowings
4. Look at the quality of the management, its governance standards and how investor-friendly the company is.
5. Mid-cap and small-cap companies can be future market leaders, so be patient with your investments
Those who wish to invest in small-cap stocks should do so only if they have a long investment horizon and tolerance for volatility. Small-cap stocks suffer the steepest falls in a bear market and rise the most in a bull market. An investor should stay invested for at least three-five years to allow their portfolio to gain from at least one bull run. If you are looking for multibaggers, stock must have high growth rates along with expanding PE ratios. The price we pay for the stock is important as it will determine whether there is enough scope left for a PE expansion to take place.
Benefits of Investing in Small Caps
1. Huge growth potential: The first and the most important advantage that a small cap stock gives you is their high growth potential. Since these are small companies they have great scope to rise as opposed to already large companies.
2. Low Valuations: Usually small cap stocks are available at lower valuations compared to mid & large caps. Hence, if you invest in good small cap companies at initial stage and wait for couple of years, you will see price appreciation not only because of growth in top line and bottom line but also due to rerating which happens with increase in market capital of the company.
3. Early Entrance Advantage: Most of the fund house and institutions do not own small caps with low market cap due to less liquidity which make it difficult for them to own sufficient no. of shares. This gives retail investors an opportunity to be an early entrant to accumulate such companies shares. When company grows in market cap by delivering consistent growth and becomes more liquid, entry of fund houses and institutions push the share prices up giving maximum gains to early entrants.
4. Under–Researched: Small cap stocks are often given the least attention by the analysts who are more interested in the large companies. Hence, they are often under - recognized and could be under-priced thus giving the investor the opportunity to benefit from these low prices.
5. Emerging Sectors: In a developing economy where there are several new business models and sectors emerging, the opportunity to pick new leaders can be hugely beneficial. Also the disruptive models in the new age is leading to more churn and faster growth amongst the nimble footed smaller companies.
Concerns while Investing in Small Caps
1. Risk: The first and the most important disadvantage a small cap stock is the high level of risk it exposes an investor to. If a small cap company has the potential to rise quickly, it even has the potential to fall. Owing to its small size, it may not be able to sustain itself thereby leading the investor into great loses. After all, the bigger the company, the harder it is for it to fall.
2. Volatility: Small cap stocks are also more volatile as compared to large cap stocks. This is mainly because they have limited reserves against hard times. Also, it in the event of an economic crisis or any change in the company administration could lead to investors dis-investing thereby leading to a fall in prices.
3. Liquidity: Since investing in small cap stocks is mainly a decision depending upon one’s ability to undertake risk, a small cap stock can often become illiquid. Hence, one should not depend upon them for an important life goal.
4. Lack of information: As opposed to a large cap company, the analysts do not spend enough time studying the small cap companies. Hence, there isn’t enough information available to the investor so that he can study the company and decide about it future prospects.
BSE Small Cap Index has not delivered negative returns for 2 consecutive years in past 16 years
We believe this is a blessing in disguise because for the first time in many years, several small companies having robust business fundamentals are available at attractive valuations. Do you know in last 16 years, small cap index have not given negative returns for 2 consecutive years. In 2018, BSE Small Cap Index has given negative returns of -23.4% and since beginning of this year, index is down by another -5.7%. Below is the table which indicates BSE Small Cap Index returns YoY since 1st April 2003 (the data is available from April 2003 onwards only in BSE).
Whenever, BSE Small Cap Index delivered significantly high negative returns in a particular year during last 16 years, it has delivered double digit positive returns the very next year. The divergence between Sensex / Nifty and BSE Small Cap & Mid Cap Index will not last for long going forward considering valuations gap emerging between large caps in comparison to mid & small cap stocks.
Tide to turn favourable for Small Cap Stocks
If you analyse the bear phase of stock markets cycle since 1990, you will find that such bear phase has not lasted for more than 18 months. Small cap index which made all time high of 20,184 in Jan 2018 with end of its bull run corrected by -35% from its peak in Feb 2019 and we believe bottom in broader markets is already in place with lows made in Feb 2019 post Pulwama attack.
Greed which was seen in broader market (small & mid caps) in the year 2016 and 2017 has turned to fear these days. Are you also fearful? This is the time to do opposite of the herd, its time to be greedy when others are fearful. If you are not investing in equities during these opportune times and taking the back seat, you are making a bigger mistake.
Remember, in the long run, you do not make decent returns on your investments by following the herd i.e. when everyone is buying stocks; instead you get handsome returns on our investments by investing in stocks at significantly low prices as no one else is buying, and by selling to them when they come back in herd due to greed in future.
Be a disciplined investor who keep on investing in systematic way irrespective of market conditions and not an emotional investor who usually buy stocks during bull phase when stock prices are moving higher because of greed and sell them in panic during bear phase due to severe fall in stock prices, making mistake of buying high and selling low.
Wish you happy & safe Investing.
Regards,
Team - Saral Gyan
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You might think that investing in mutual funds could be one of the way to start SIP (Systematic Investment Plan). However, returns may not be that high which you can generate by directly investing into good quality small and mid cap stocks. Hence, we suggest our members to start SIP by directly investing in stocks every month. What you are suppose to do is to invest your savings in a particular stock once in a month instead of putting it into mutual fund. Next month, same amount would be invested in another stock which at that point of time gives you good medium to long term investment opportunity. This could be an ideal choice for salaried employees as well as businessmen / entrepreneurs, as it will help you to directly invest in fundamentally strong small and mid cap companies to build a diversified portfolio of high quality small and mid cap stocks over a period of time to achieve wealth creation.
