What is multibagger stock and how to spot it?

As a newbie entering the world of the stock market you think of it as a big life-changing opportunity. Immediately you start the search for the next big thing which can probably give you an early retirement and change your fortunes. Companies such as Asian Paints, Pidilite, MRF, Eicher Motors, Hero Honda, etc are the names that immediately come to your mind when you think of wealth creation.

These are the companies that define what a multibagger is. By definition, multibagger is a company whose share price has appreciated by more than 100% in a given period. However, when we think of multibaggers we generally think about companies whose share price has appreciated by 5-10-15-20x and has created massive life-changing wealth for its investors. The term was coined by Peter Lynch in his book “One Up on Wall Street”, which by the way is one of my favourite books on investing.

Formula of Multibaggers:

Any stock that has the following lethal combinations or a set of them would have a massive potential to be a big multibagger:

Visionary management + scalability + pricing power + tailwinds + high growth + higher incremental RoCE + low equity + under ownership + leader in a niche area = combination of a multibagger.

Some Fundamental Patterns that should be kept on the radar to spot a Multibagger:

(i) The Negative Working Capital Pattern: In the extremely competitive business environment that we currently operate it, any company that receives advance from its suppliers should be noted and studied carefully since it is a sign that maybe company has that niche which the competitors do not have. These are businesses where the business operates on Other People’s Money (OPM) or the suppliers money. Advances from Customers is a good hint to go by.

(ii) Companies which are the leaders in niche area with tiny market caps: Once they grow and the market realises their potential, you get huge multi-baggers. This reminds us of the domestic consumption stories. If one looks back the marketcap of a Cera or a Symphony or a La Opala they were just too minsicule compared to the scale they catered to. Had their supply chain and distribution network in place. Tailwinds followed and the market took them to a different orbit.

(iii) Demerger in sizeable company: FII have got market cap stipulation and hence they tend to sell out in haste without even caring about the intrinsic value. Marico Kaya, Aarti Surfactants, Suven Pharma, Solara Active being examples of huge value creation.

(iv) Companies eating Market Share of Market Leaders: Amara Raja, Havells are good examples as they took market share from market leaders Exide and Crompton Greaves.

(v) Second run companies in sectors where the leaders been multibaggers: At some time the valuation gets so stretched that investors start to look for the smaller peers and the valuation gap narrows. Avanti-Waterbase, Relaxo-Mirza, KRBL-Chaman Lal are good examples.

(The writer is Kolkata-based investors. Views expressed are personal. Malani is known for identifying stocks like Avani Feeds, Bharat Rasayan, Apollo Tricoat, among others in early stages.)