How to find a potential multibagger stock - explained (2024)

What is important is to follow the process of identifying good businesses and then look at both qualitative and quantitative data points.

Also another important thing that investors should note is that patience and conviction are the building blocks before multibagger stocks get created. This process and time line could take anywhere between 2-3 years or sometimes even less than a year to culminate in to a multibagger

Also an investor today cannot make money from the past. One of the characteristics of a multibagger stock is that it should have immense growth potential in the future. The best way to understand future growth potential is by reading the vision and mission statement of the company. You can find it in the annual report of the company.

If a company is very vocal about its vision and is able to explain the steps being taken by the management to achieve them, then the company has lot of future growth potential

Small-sized companies can also have the right characteristics of a multibagger stock, especially if its a market leader in the business segment. Many companies that are smaller in size but have captured large market share in their niche have the potential to become multibagger.

There are two ways a company can grow. Organic growth and inorganic growth. Organic growth is when the company expands its business by investing capital and creating assets.

When companies follow inorganic growth, they start acquiring assets of other company by acquiring or taking over their business.Organic growth is a great way to expand and grow a business, but it takes time as companies have to create assets from scratch. Inorganic growth on the other hand, if done right, is a much faster and better approach to expanding a business.

So what are the basics which one must check to start looking for multibagger stocks ?

Is the company offering a unique product? Companies like Coca Cola have achieved durable competitive advantage by patenting the formula they use to manufacture their beverages, providing a unique product no other company can copy.

Is the company having a big brand or is a Monopoly? Brand means trust. When people trust a brand, they are willing to pay higher price for it. This allows the company to command higher margins and consistent sales for a unlimited period of time.

The management of the company is the heart of a business. The second most important characteristic of a multibagger stock is honest management.An honest management discusses its business goals clearly and presents a blueprint on how it is going to achieve it.

However just talking about growth is not good enough. An honest management must be able to demonstrate a plan or a blueprint about its growth estimates. A clear, and time bound targeted goal must be laid out in front of investors.

In order to understand how ambitious the management of the company is, you need to look at its past performance as well. Analyze the past performance of the company, what goals and plans they had, and how successfully they have achieved, them. If the management has missed its past targets by wide margins most of the time, better be cautious and tread carefully, history often repeats itself.

Also in most multibagger stocks one will find that promoters will have high equity stakes and very limited public shareholding. Companies which dilute equity frequently will not find favour from markets as this will cut down the ROE and earnings growth going ahead.

Also Multibagger stocks emerge from companies which use their financial resources with prudence. Another evidence of financially conservative management is that they generate lots of free cash flow (free cash flow = cash flow from operations- purchase of fixed assets). The free cash flow can be used to fund future expansions or pay dividends to shareholders.

The first important factor among quantitative characteristics of a multibagger stock is high earnings growth.Understanding how fast a company is growing is critical to evaluate its financial performance. While there are many ways to calculate earnings growth (such as therevenue growth model, profitability model etc), one of the most accurate measure is EPS (Earnings Per Share) growth.

Multibagger stocks usually command higher profit margins. This is due to the fact that they have little or no competition or have a strong brand presence allowing companies to charge a premium over the products or services offered. Multibagger stocks command higher profit margins that their peers. As a thumb rule, a potential multibagger stock should have profit margins above 10%.

Debt can destroy a company’s business. While picking multibagger stocks for investment, make sure they do not have huge debt on their books. A debt free company is the best candidate for multibagger stock.

Also the most important characteristics of a multibagger stock is that they generate high free cash flow. The reason why free cash flow is so important is because it is difficult to manipulate cash flow numbers, due to which investors get a clear picture of the company true financial performance.

However it is important note while analyzing the free cash flow of a company. If a company has negative free cash flows it does not necessarily mean that company financials are deteriorating. When companies expand their business aggressively, they spend a lot of capital acquiring assets, using their free cash flow. Since these assets are expected to generate more cash in the future, negative free cash flow is not bad if the company’s capital expenditure is increasing.

So this factor is also important when one looks at multibagger stocks going ahead. And finally after these data points, it is important to find out what ROE and ROCE is the company generating – atleast 15 to 18% initially is desirable and then whether this can be scaled up to 25 to 30% and above going forward. A high ROE rerates a stock to higher valuation multiples in future which results in massive wealth creation creating multibaggers.

In conclusion the most asked question is also where to find such multibagger stocks ? There are many free secondary resources like Annual Reports, company presentations, quarterly conference call transcripts, quarterly results, but primary sources like company interactions, field visits to dealers, suppliers and customers give a better sense of finding future multibaggers, Finally it’s a process driven model which helps us to find multibaggers going ahead.

*Avinash Gorakshkar is Head of Research at Profitmart Securities. Views expressed are completely personal and not of Mint.

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Published: 09 Apr 2023, 01:30 PM IST