The Most Overlooked Ingredient of a Multibagger Stock - The 5 Minute WrapUp by Equitymaster
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The Most Overlooked Ingredient of a Multibagger Stock

Dec 3, 2015
In this issue:
» The tepid response of retail investors to IPOs
» E-commerce poster boy continues to bleed
» ...and more!
00.00
Rahul Shah, Co-Head of Research

If your investment grows by 25% per annum for ten years, your capital swells to 9.3 times its initial size. That's a fabulous result whichever way you look at it.

Market insiders wistfully refer to those kinds of returns as 'multibaggers'. For many investors, this is the ultimate goal - the holy grail of investing.

So what does it take for a stock to deliver a scorching appreciation of more than 25% per annum?

To answer this question, we took the stocks that make up the BSE 100 index and had a look at which of them have been able to deliver multibagger returns to investors over the past ten years.

Here's what the results look like:

  Company Name Stock Price 10 Years Back Current Stock Price 10 Year Change in Price CAGR Return P/E Ratio 10 Years Back P/E Ratio Now
1 Eicher Motors Ltd. 250 16,232 6,383% 52% 3 53
2 Lupin Ltd. 77 1,812 2,267% 37% 33 39
3 Aurobindo Pharma Ltd. 40 825 1,981% 35% 19 29
4 IndusInd Bank Ltd. 57 940 1,558% 32% 9 28
5 Asian Paints Ltd. 54 844 1,462% 32% 30 52
6 Divis Laboratories Ltd. 75 1,137 1,425% 31% 29 35
8 Kotak Mahindra Bank Ltd. 54 687 1,162% 29% 39 41
9 LIC Housing Finance Ltd. 41 484 1,091% 28% 12 18
11 Titan Company Ltd. 34 378 1,011% 27% 138 41
12 Sun Pharmaceutical Ind. Ltd. 69 730 964% 27% 32 45
13 Godrej Consumer Products Ltd. 120 1,251 946% 26% 25 42
14 Dabur India Ltd. 29 279 865% 25% 32 42

Data Source: Ace Equity

As you can see, from the hundred stocks that make up the BSE 100 index, just 14 have delivered returns in excess of 25% per year.

But here's the point to note: Most investors think that the key to a high-return stock is always earnings growth, so that is what they focus on when they look for holy-grail stocks. Now, that may be true in our results too, but it is far from the complete story...

A careful look at the table above reveals that all of these stocks, barring one, have another important factor in common - a large increase in their price to earnings (PE) ratio.

Perhaps it is no coincidence that the stock that has delivered the most staggering returns over the last ten years - Eicher Motors - has also seen the biggest increase in its PE ratio.

But how most of these high-return stocks have seen their PE ratios go up offers a valuable lesson for investors.

Many 'growth stock' investors are ready and willing to pay almost any price for a stock as long as earnings are expected to grow at a high rate. But as our results show, if you're looking for multibaggers, stocks need two ingredients: high growth rates, yes, but also expanding PE ratios.

And for the latter to work in your favour, the price you pay for the stock is important. Because it is only your purchase price that will determine whether there is enough scope left for a PE expansion to take place.

So be sure not to overlook this important factor while searching for the next multibagger stock.

What are the factors you look at while search for multibagger stocks? Let us know your comments or share your views in the Equitymaster Club

2.18 Chart of the day

If today's chart of the day is any indication, retail investors seemed to have developed a bit of a phobia when it comes to investing in IPOs. As the chart highlights, in almost all the big ticket IPOs that have hit the markets in recent times, the retail subscription has been way below the overall subscription the issue eventually garnered. As a matter of fact there are a couple of cases where the issues have not even been fully subscribed.

Is it a case of the companies leaving too little money on the table for retail investors in order for them to get tempted? We don't think so. From whatever we know about IPOs , most of them come at expensive valuations anyway and leave very little room for further upside. Therefore, this cannot be the reason for retail investors suddenly developing cold feet.

We are of the view that the poor response has perhaps mostly got to do with the sentiments being not that great currently and investors being cautiously optimistic. Once greed returns, retail investors could once again be seen making a beeline for IPOs. Although for their sake, we really hope they display cautiousness and buy only the ones that come with reasonable valuations and strong business models.

Are retail investors suffering from IPO phobia?
3.18

Indian e-commerce companies may have gotten their revenue model bang on but a successful template of extracting profits out of these revenues still eludes them. And leading the charge for this embarrassment of sorts is none other than the sector's poster-boy Flipkart. As per a leading business daily, the company has posted a loss of a whopping Rs 20 bn for the year ended March. The loss amounts to a huge 20% of the company's total sales during the period. The sad part is the company may not be done bleeding yet. It may have to keep sustaining losses as it seeks to offer more and more discounts in view of the really intense competition.

While we may be in a minority, we for one don't believe in this 'profits may come later' strategy at all. Please note that the company has scaled up immensely over the years and yet, the burn rate or the rate at which it is losing money, doesn't seem to be coming down. And if the profits haven't yet started flowing in, we don't know what change in the model will eventually make them a reality. We are sorry but we are not getting a good vibe about the viability of these e-commerce companies as things stand today.

4.48

The Indian stock markets were trading weak today on the back of sustained selling activity across most index heavyweights. At the time of writing, the BSE-Sensex was trading down by around 130 points. Losses were largely seen in pharma and FMCG stocks.

4:56 Investment mantra of the day

'All you need for a lifetime of successful investing is a few big winners, and the pluses from those will overwhelm the minuses from the stocks that don't work out.' - Peter Lynch

This edition of The 5 Minute WrapUp is authored by Rahul Shah (Research Analyst).

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Equitymaster requests your view! Post a comment on "The Most Overlooked Ingredient of a Multibagger Stock". Click here!

1 Responses to "The Most Overlooked Ingredient of a Multibagger Stock"

K.P.Janakiraman

Dec 7, 2015

It is a good & interesting point.My next work will be to check your point at some of your recommended stocks where the ERM was above 7.0.Should i check one your old or recent stocks.

kpj

Like (1)
  
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