How To Pick Multibagger Stocks: One of the principal reasons why several first-time investors get attracted to the stock market is that they get carried away by the potential of high returns.
While every investor desires to own multibaggers in their investment portfolio, it is not an easy job to pick such types of stocks.
But what do we mean when we say Multibagger stocks? Well-known investor “Peter Lynch” coined this term ‘multibagger.’ As the name depicts, it means shares of a company that is capable of delivering returns multiple times higher than their associated cost of acquisition.
Precisely, these kinds of equity shares offer investors a return of more than 100%. Multibagger stocks are often picked from high-growth industries. With a healthy financial position and solid market growth opportunity, multibagger shares are generally undervalued.
These characteristics of shares make them an ideal investment proposition. Identifying and investing in a multibagger stock can help you grow your wealth exponentially.
But how do we identify these multibagger stocks? Well, this is a tough one to answer. However, there are simple rules which can help investors to pick stocks at the right time that are potentially more promising and can double investors’ wealth in a disciplined manner.
ALSO READ: 5 Multibagger Stocks in India in the Past 5 Years
How To Pick Multibagger Stocks, and invest in a multibagger stock.
- Earnings Growth and High Return on Capital Employed: The first step in this journey is to identify stocks that have seen high earnings growth. We need to make sure that this earnings growth has been achieved without deteriorating return on capital employed.
The earnings growth needs to be sustainable and diversified. Too much reliance on one customer for earnings can hamper its growth in the near future. Therefore, stocks that compounded their earnings at a higher return on capital employed are the ideal ones.
Debt levels of the company can also impact its earnings. Hence, debt needs to be within reasonable limits. Though prior performance does not guarantee future performance, it can give an idea about its track record.
Past performance can indicate whether revenues have the ability to increase consistently or not. If operations of the company are scalable, its shares can turn out to be multibaggers.
- Growth in Cash Flows One of the most important yardsticks to analyze the company’s performance is its cash flow. The cash flow statement helps determine the company’s ability to increase earnings over the medium to long term.
Multibagger companies have the potential to compound their operating cash flows which can help them grow at a fast pace. Therefore, in your search for multibagger stocks, it is of utmost importance to look for companies having a track record of higher cash flows.
- Long Growth Runway: Since investing your hard-earned money in a new company can prove to be stressful, look for the companies having a long growth runway. Having a longer runway means that the company has the potential to expand into new avenues which can provide significant growth opportunities. This growth can translate into improved earnings per share.
- Lower Threat of Competitors: Exiting a competitor can result in market share gains by the remaining ones. Having a sound market share and sustainable competitive advantage can result in windfall gains for customers. These gains can be translated into higher revenues. Eventually, the company can see a higher value and increased P/E ratio.
- Expansion Plans into High-Margin Businesses: Higher P/E growth can be easily achieved by a company embarking on a journey to expand into high-margin businesses. Exiting the low-margin ones can also help in the management of costs. Management’s decision to work on an optimal business mix can result in strong growth in EPS and P/E ratio.
- Small Companies with Strong Product Demand: The size of the company generally plays a pivotal role in evaluating at what rate investors’ money can grow. Usually, smaller companies find it easier to be multibaggers than larger ones.
Therefore, it is fair to say that a company having only 5-6% of the market share holds more potential to be a multibagger than a company already holding 40-42% market share.
This is true principally because of the lower base of the smaller company and the growth opportunities available. Apart from looking at the size of the company, it is equally important to look at the demand for its products, and the gap that those products bridge.
Growth in EPS and the P/E ratio are two main indicators that help in determining the potential multibaggers. These stocks are generally lesser-known to the general public, and they don’t favor a specific industry.
While multibaggers can actually result in windfall gains, these stocks can erode investors’ wealth at the same time. Therefore, we need to observe utmost caution and look for the factors written above when going long on these companies.
Now we’ve gone through, How To Pick Multibagger Stocks we hope you learned more than you knew before reading this article on “How To Pick Multibagger Stocks”. To get a better understanding of stock market investing, check out our free course below. As always, Happy Investing!
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