Multibagger stocks are by definition stocks that have the potential to multiply your wealth in a tremendous way. Let's see how !
If you look upon the history of stock markets you will find many multibaggers like Cera sanitaryware, La-opala, page industries, Ajanta pharma and many more. Have you ever thought of what made these stocks stand out from other stocks? All these multibagger shares have common characteristics and qualities that made them stand out.
We will discuss the 4 such qualities that were present in each of past multibagger and you should definitely take care of these characteristics while making an investment decision or to check out that whether the stock that your friend or broker or some news channel is selling you has that potential or not.
1) Business Growth - Whenever you invest in any asset class may be it real estate or gold or equities you want it to grow and earn money, similarly an emerging company also aspire to boost its revenue growth and profit growth like acquiring new customers, expansion into new products, launching in new geographies to gain market share etc.
With sales growth you need to look upon to profit growth also as both are important to a business. If the company is generating good sales but not able to convert that sales to profit than it indicates that company has some problem with its operating matrix or the margin is deteriorating or may be the company is not able to manage its cost resulting in losses. There may be many other reasons for it. However, the point is to look for both sales and profit growth.
The question that comes now is how much sales & profit growth should you look for. History speaks it all and "It's never different this time". Thus, observing all these multibaggers in the past you should look for companies growing revenue and profit by atleast 15-20%. In best of the cases before the big price run up you will see sales and profit growing by 50-60%. However minimum 15-20% is what you need to look for.
2) Low on Debt - A company that doesn't need outside cash to manage its operations and to fund its business is an attribute of successful multibagger companies in past. A company able to do this implies that its business model is robust and self-sustaining. In terms of number the debt/equity ratio should be less than 1 and decreasing trend and in best of the cases these would be Net cash companies.
Businesses operate in business cycle and when the business cycle is in favour debt has its own advantages as the company would be able to use that debt into better margin business. However, when the cycle is turning around and the bad time comes there are ample examples like Sintex, Kwality, Rcom and many steel companies that went to NCLT as they were not able to survive those bad times when business was suffering and interest cost was making it worse for them to come out. Thus, net cash companies and low debt companies (D/E <1 & decreasing trend) were those that came out successfully and made killing again when the business cycle turned again in favour.
3) Cash flow from Operations (CFO) - CFO indicates the cash generated by the company after taking care of changes in working capital and day to day operations. A company may be generating good profits but if the company is not able to convert those profits to cash it indicates poor working capital management or the business itself is of such nature that it requires long delay to receive cash for the goods sold. This is also one of the reasons why company go for debt as the self-cash generation ability is poor. One should look for positive cash flows from operation and improving over years.
Also, profits are book accounting figure derived from profit and loss account which can be manipulated by the management to show to good profits over years. However, a close study to cash flows would reveal that the cash flows would be deteriorating as the receivable would increase thus a warning sign or any other reason.
4) Healthy return ratios (ROCE/ROE) - Return on capital employed and return on equity determines company’s overall effectiveness and the amount of return that it earns on its capital in the business. Again, history gives us many leads that indicates, a company with multibagger potential has healthy return ratios and healthy would mean atleast 15% ROCE/ROE
Thus, before investing in any company with a believe that it would be multibagger in future you should look upon the above characteristics as the above numbers and qualitative characteristics are historically derived from past multibaggers. A combination of these 4 is very powerful and applying these to your investment thesis would eliminate most of the bad companies leading to the good bunch of companies. However, you must note that apart from these one needs to research more about the company and its future prospects, management, market size as these are inclusive and not exclusive.
CA Devang Maheshwari