A Sure Shot Way to Predict a Multibagger Stock - The 5 Minute WrapUp by Equitymaster
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A Sure Shot Way to Predict a Multibagger Stock

Apr 17, 2018

Tanushree Banerjee, Editor, The 5 Minute Wrapup

An economist once went to the movie theater.

He noticed that Coke and popcorn were priced way too high relative to their prices elsewhere. Yet they sold like hot cakes.

The poor soul was so puzzled, he spent hours researching on it. He could understand why first-class airplane seats sold for more than train coach seats.

But all his theories couldn't help him understand why coke and candy bars sell for so much at theaters.

Charlie Munger once narrated this story to his partner and world's richest investor, Warren Buffett.

In fact, this was the story that laid the foundation of the Buffett-Munger partnership.

You see, before he met Munger, Warren Buffett used to invest like his guru, Benjamin Graham. In the first few decades of his career, Buffett would mostly invest in deep discount stocks. Following the principles of Benjamin Graham, Buffett rarely looked for things like management quality and pricing power of the businesses.

Years later, Munger put across his rule of buying great businesses with these words...

  • There are actually businesses, that you will find a few times in a lifetime, where any manager could raise the return enormously just by raising prices-and yet they haven't done it. So, they have huge untapped pricing power that they're not using. That is the ultimate no-brainer.

Buffett listened to Munger.

And together they identified many examples of pricing power.

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They bought Disney, Coca Cola, See's Candy, Washington Post, and Gillette for this single reason.

Decades later, Buffett bought Lubrizol in 2010. Lubrizol had raised prices 18 times between 2004 and 2010, without hurting its market share.

  • The single most important decision in evaluating a business is pricing power. If you've got the power to raise prices without losing business to a competitor, you've got a very good business. And if you have to have a prayer session before raising the price by 10 percent, then you've got a terrible business.

    - Warren Buffett, 2011 (Financial Crisis Inquiry Commission)

Here's an Indian example...

IIM Ahmedabad is the most premier management institute of India. You may have read the news recently about its fee hike.

I wasn't surprised to learn that it has raised tuition fees every year for past sixteen years.

And that too, at an average compounding rate of 18%.

Of the 4,000 odd management institutes in the country, hardly any have the kind of pricing power of IIM Ahmedabad.

In fact, if IIM Ahmedabad would have been a listed private company, its stock would have gone up 14 times in past sixteen years.

Simply by virtue of its pricing power!

If IIM Ahmedabad Was a Listed Stock...

Now, do keep in mind that the opposite also holds true.

Just as pricing power helps businesses create shareholder wealth, the lack of it can destroy wealth.

How?

Just look at the top telecom companies in India.

They had healthy financials about a decade back. But intense competition and lack of pricing power brought them to their knees. Shareholder wealth is a now a thing of the past for the sector.

See today's chart of the day for more on this.

So, never assume that a business which grew 10 times in the past will repeat that feat.

Check its pricing power.

Some of my oldest StockSelect recommendations like Asian Paints and Titan, pass this test even today.

Chart of the Day

One of the biggest and most resilient telecom companies in India, Bharti Airtel, has been the victim of loss of pricing power in the sector. Sliding operating margins had a direct impact on the company's return on equity over the past decade. And the poor operating numbers apart from debt heavy balance sheet weighed on the valuations.

Bharti Airtel's Sliding Valuations

Warm regards,
Tanushree Banerjee
Tanushree Banerjee (Research Analyst)
Editor, The 5 Minute WrapUp

PS: Tanushree has made a prediction: Sensex 100,000. If she's right, there will be a lot of winning stocks. Some may already be in your portfolio. But you'll also miss out on some. However, you don't need to take unnecessary risks to make solid double or triple digit gains. Tanushree's premium service StockSelect, will safely guide you to the best stocks in the market. You can get full details here...

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2 Responses to "A Sure Shot Way to Predict a Multibagger Stock"

Ramendra kumar

Apr 21, 2018

Good one

Like 

Anand

Apr 17, 2018

Very thought provoking article. A sure eye opener. Your example on telecom companies was very apt. Reading the articles by most of you at EM, has cleared many cobwebs in my mind.

Like 
  
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