Aug 26, 2011|
How to identify multi-baggers?
"You can't buy what is popular and expect to do well" - Nothing better than this quote from legendary investor Warren Buffett provides a concise explanation/answer to the title/question of this story.
Multi-baggers typically never hog the limelight. In fact, they lie in the world of ignorance. Traditional finance theories are not useful in indentifying hidden gems. So, how does one go about finding these potential winners of tomorrow?
Well, we believe the most important factor to identify potential multi-baggers is the ability to take a call on broader macro-themes when the uncertainty factor is at its peak. Classic examples could be: - a) A company engaged in solar power generation b) A company engaged in disposing solid & liquid waste in an eco-friendly manner.
The crux lies in identifying opportunities way ahead of the markets. And this gives us the "price" advantage. Remember, it is price which determines the ultimate return on your investment. Buying at a reasonable price with respect to the growth prospects entails margin of safety - a very important factor especially when it comes to investing in sunrise companies. As the risk-reward ratio is high (chances of the idea materializing as expected is rare due to high uncertainties) buying low brings in a lot of comfort.
Amongst other factors include - patience. Remember, in identifying multi-baggers you are effectively taking a call on a prominent theme that is likely to emerge in future. Non-conducive environment and regulatory hurdles could mean that it would take a while for the theme to emerge.
Take the case of Bharti Airtel for example. In early part of 2000, the company was struggling with losses. The business was capital intensive with high regulatory uncertainties. But what overplayed these concerns was the concept of migration to mobile telephony. And investors who had the ability to foresee such an environmental change were hugely rewarded (India is a populated country and hence the migration phenomenon was pretty much on the cards). However, it may be noted that it took a while before the theme emerged. Hence, patience and belief in ones conviction is of prime importance when it comes to identifying multi-baggers.
Scalability of the business model and management depth/quality also assumes equal weightage. Scalability is critical because an idea needs a free market to prosper. One cannot expect a multi-bagger from power sector where RoEs are capped or from Oil & Gas sector where prices are regulated. Consumption theme fits the criteria of free markets. Take the case of Bharti Airtel, Titan Industries or Pantaloon Retail. They all have been consumption plays in a way.
While it is difficult to gauge management perception examining return ratios gives us a good sense of profitability and also management's intention of maintaining this profitability. Growing businesses with faltering return ratios is not a good symptom. Capital allocation decisions by the management also prove to be a useful sign.
And last but not the least, it is important to note that when the idea emerges, do not get disappointed if the market is highly critical about it. In fact, one should find resonance in the fact that since it lies in the world of ignorance (we just spoke about) you could probably be sailing in the right boat.
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