Many investors are obsessed with identifying future multibaggers. How can you find multibagger stocks? Unfortunately, it’s not easy. In this article, we look at a specific research report that addresses how to find multibaggers.
The main takeaways from the report are that the Nordic region is a great place to invest, don’t be too obsessed with valuation multiples if the company and its management is great, and don’t spend time on companies that have problems. Turnarounds seldom turn into multibaggers.
A new research report called The Makings Of A MultiBagger has recently been frequently “retweeted” on Twitter. Three summer interns conducted a study at Alta Fox Capital in 2020. The results reveal the Nordic region is an excellent place to park your money, and you shouldn’t be too obsessed with valuation multiples if the company is of “high quality”. The results are impressive, but the methodology has significant flaws.
What does multibagger mean?
Let’s first define a multibagger:
It’s a stock that has multiplied its share price several times over a specific time frame. For example, a stock trading at 10 USD ten years ago and now worth 100 a share has multiplied ten times.
The origin of the word multibagger was first mentioned in Peter Lynch’ bestseller One Up On Wall Street in 1988, presumably an expression derived from the sport of baseball.
The safest way to get multibaggers
Most investors dream of finding multibaggers.
Unfortunately, as you’ll learn after reading this article, this is extremely difficult.
The stock market is heavily skewed toward just a few stocks contributing to much of the wealth creation, and these stocks are, of course, not easy to find.
Research shows retail investors underperform the major indices, and we believe most investors are better off investing in a portfolio of different mutual funds. It’s not as exciting as looking for the next multibagger, but if you’re patient, you will indeed have multibaggers among your funds:
The multibagger study’s methodology
The research project aimed to identify common characteristics, trends, and catalysts that turned small-cap stocks into multibaggers in North America, Western Europe, and Australia. Energy, material, and financial stocks were excluded from the database, and the students looked only at data from June 2015 until June 2020 in stocks with a market cap of at least 150 million USD and a maximum of 10 billion USD. A multibagger must have risen at least 350% during this period.
Only 105 companies fulfilled their criteria. The research aimed to identify strategies to find the next set of high-performing stocks.
The seven takeaways to screen for future multibaggers
Below are the seven significant findings from the study:
The Nordic region is overrepresented:
The study found the Nordic region was over-represented among the sample. This is no surprise. Much research has concluded the Nordic markets have produced returns just as good (or better) as the US markets.
The US is under-represented among the winners:
Tailwind from megatrends is important:
The best sectors were technology and healthcare:
We can argue both technology and healthcare get a boost from the structural change in globalization. However, that doesn’t mean it’s easy to pick winners. Just a few companies take most of the markets:
Consumer staples tended not to outperform as often, but we would assume they are also less likely to go to zero.
High multiples can still generate fantastic returns
Many of the companies already had high multiples in 2015. If you get it right and the company grows its business, you can still make exceptional returns:
Revenue growth is important to become a multibagger
Just like Philip Fisher wrote several decades ago, revenue growth is a good indicator for future earnings. It’s next to impossible to tamper with the revenue, while earnings can easily be “manipulated”.
Multibaggers often make acquisitions
Acquisitions were vital to 56% of the revenue growth. M&A is tricky to perform, but many organizations/management have the skills and knowledge to create value via acquisitions. By looking at the history of the acquisitions made you get a pretty good indication of their abilities. However, be aware of significant and transformative acquisitions. Just one deal can ruin the company.
Turnarounds seldom turn into multibaggers
None of the winners were “turnarounds”, i.e. companies that might have suffered temporary setbacks and is now looking for ways to turn around their business. The authors suggest investing in financially healthy companies.
Multibaggers need a moat around their business
The study recommends investing in companies that have an advantageous position in the markets (called moats by Warren Buffett). The most likely moat is via the network effect, but cost advantages, intangibles, and switching costs were mentioned.
Survivorship bias and hindsight bias
The whole study is, unfortunately, based on hindsight bias.
The authors took a sample of stellar performers and look at the factors they believed were the main drivers of the growth.
However, one major flaw with the analysis is no consideration of the losers. They started by looking at the winners. This is what they wrote at the start of the research project:
Analyzed the highest performing stocks over the last five years and identified their common characteristics, trends, and catalysts.
They ignored the obvious question: How many of the losers had the same characteristics?
Of course, we will never know because they didn’t look at the losers. In other words, they look at just a small market sample by ignoring the losers.
Undoubtedly, many losers showed the same attributes as the winners back in 2015. A more useful approach would have been to look at all companies back in 2015 with specific attributes and then at how they performed, both winners and losers.
Another significant issue is the short time period: only five years.
Picking stocks is difficult, small-caps even more so
Hendrik Bessembinder is famous for his study published in 2017 called Do Stocks Outperform Treasury Bills?
His findings revealed that only 42.1% of common stocks have a lifetime return that exceeds short-term Treasuries from 1926 to 2015, and about 50% of stocks deliver negative lifetime returns.
Most of the returns are skewed to just a few stocks. 86 stocks out of 26 000 accounted for half the value creation! The average or median stock performs poorly, it’s the few outliers that make all the returns.
The results are even more skewed for small-caps: just a tiny fraction of them lives on to grow and prosper. Many of them have unproven business models, and many more companies start than what later is needed. Very few hit it big; most hit the dust.
However, we can argue private investors have an edge in small caps compared to big financial institutions. The main reason is the size of them, which limits big funds from investing.
The study suffers from hindsight bias and survivorship bias, but still offers some insights on how to spot potential multibaggers: The Nordic region is a great place to invest, don’t be too obsessed with valuation multiples if the company and its management is great, and don’t spend time on companies that have problems.
Disclosure: We are not financial advisors. Please do your own due diligence and investment research or consult a financial professional. All articles are our opinion – they are not suggestions to buy or sell any securities.
– How can I find multibagger stocks?
Finding multibagger stocks is challenging but involves considerations such as investing in regions with growth potential, prioritizing company quality over valuation multiples, and avoiding companies with inherent problems.
– What are the main takeaways from “The Makings Of A MultiBagger” report?
The report suggests that the Nordic region is an excellent investment destination, advises not to be overly obsessed with valuation multiples for high-quality companies, and emphasizes avoiding companies facing problems.
– What was the methodology of “The Makings Of A MultiBagger” study?
The study aimed to identify characteristics that turned small-cap stocks into multibaggers in North America, Western Europe, and Australia. The research excluded energy, material, and financial stocks, focusing on specific market caps and time frames.