How did you zero in on the concept of a 100-bagger? Why did you choose to make it the subject of your wealth creation study?
This report would most likely have been titled ‘demystifying growth’. But then we came across the book 100 to 1 in the Stock Market by Thomas W Phelps, who is described as a private investor, columnist, analyst, author and financial advisor. Written in 1972, the book makes a strong case for investors to “buy right and hold on”. It offers examples of how over 365 stocks in the US appreciated 100 times or more over the 40-year period ending 1971.
The importance of this book is that it led us to think about growth and understand the power of growth in investing, particularly in identifying some of the future multi-baggers. This was the starting point for the study. Growth is crucial to investing but is not discussed much in India; there is an incomplete understanding of the subject.
How did you adapt your findings to the Indian context?
Our investing style is primarily concentrated on quality, growth, longevity and price. Of the four, growth is the most neglected variable. For instance, how do we measure growth, value it and decide whether it is secular? Growth is the biggest force that changes the value of a company. Infosys was a ₹50-crore entity that went on to become a ₹2-lakh-crore IT powerhouse. The transformation came about because of the underlying growth in the IT business. Had it not grown, Infosys would not have achieved this size and scale. So, growth is very important. The next pertinent question would be: where do we search for such high-growth ideas? Of all the growth stories, one needs to think which one is going to be around over the next 20-30 years and is currently under the radar.
Could you elaborate on what this framework threw up when applied to the Indian equity market?
The BSE Sensex had a base of 100 for the year 1979. It first touched 10,000 in February 2006, that is, 100X in 27 years (almost 19% CAGR). As of March 2014, the Sensex was at the 22,400 level. It was at the 224 level in 1984, that is, 100X in 30 years (a CAGR of 17%). Given such a strong performance of the benchmark index itself, smart investors should aim to beat the benchmark and achieve 100X in 20 years at the most (that is, a CAGR of 26%).
Our study showed that 100x stocks on an average take 12 years to rise hundredfold, that is, a 47% return CAGR, and in a given timeframe, 100X investment opportunities are much more widely available than 100X investment ideas. If 100X takes 50 years, the effective annual return is only 10%; if it takes 40 years, the figure would be 12%. In the Indian context, the long-period return of the benchmark indices is around 17%.
Thus, if a stock takes more than 30 years to rise hundredfold, it would most likely end up underperforming the market. Given this, even investors with long-term outlook should reject such slow-growth 100X ideas. Hence, we believe that the single-most important determinant of stock market return is growth in all its dimensions — sales, margin and valuation.
What makes a 100-bagger?
Mathematically, sales volume growth multiplied by sales price growth multiplied by margin, and valuations expansion is the possible source of a 100-bagger. Simply put, growth in share price will be directly influenced by growth in sales volumes and sales price, along with expansion in margins and valuations. If all these things happen simultaneously, it could be a huge game-changer. It is possible for a smaller company to grow its sales by 20-25% annually. However, sales turnover cannot be seen in isolation. If a stock is trading at 30X and margins are going to double, for me it is a 15 PE stock.
We now know what margins can do to valuations. Similarly, if a stock is currently trading at 10X and after a few years starts to trade at 30X, one can imagine what impact valuations could have on a higher earnings base. It is a combination of multiple variables that have to work together to create a 100-bagger. It is impossible to think in terms of 100X sales or 100X volume growth for a particular company. But even with 20-25% annual sales growth, if other levers such as margins, return ratios and valuations expand, it is quite possible for an investment to turn into a 100-bagger.
What do you mean by 100X investment opportunities being more important than 100X investment ideas?
Of the total 3,500 listed stocks, the prospect of finding 100X stocks — we found 47 such stocks in our study over a span of 15-20 years — may sound like trying to look for a needle in a haystack. However, what is interesting is that over the 16-year period between 1994 and 2009, the number of 100X opportunities (a stock may offer you multiple entry points to make 100X) was much higher at 163. This is because most 100X stocks offer multi-year windows to buy into them and still rise 100X from that level. In fact, the average number of opportunities in the first 11 years is a high 14. A decent strike rate from this level will work wonders for any portfolio.
For instance, Motherson Sumi and Shree Cement offered the highest number of opportunity years (11 each). Both these stocks could have been bought anytime between 1994 and 2004 and the stock prices would have risen hundredfold thereafter. Likewise, Lupin offered a nine-year buying window from 1995 to 2003. Even Infosys, by far the highest multi-bagger, could have been bought any time between 1994 and 1998 for a 100X experience.
But the difference would be in the price appreciation multiple: 2,900X if bought in 1994 and 209X if bought in 1998, if held through all the way to March 2014. The key takeaway is that an investor need not worry even if he or she missed a multi-fold price rise in a potential 100X by not buying into its initial years. In other words, when it comes to 100X stocks, it is dawn when you wake up. Or, more accurately, when the 100X idea dawns on you, simply wake up and buy the stock. But there is one check you still have to carry out when you buy the stock: does it still carry the essence of 100X?
What are the pitfalls of this strategy?
One should not fall into the trap of compromising on the quality of growth. In 1960, Phil Fisher said that in investing, 90% is the management, 9% is the business and only 1% is other things that matter. If the management is strong and the business is good, nothing else matters. At one point, HDFC bank was available at ₹700 crore-800 crore; today, it is a ₹2.5-lakh-crore bank. At some point, valuations are less important, particularly when you are buying a small-sized company’s stock. I believe valuations are less important, particularly when buying shares of small-sized companies that tend to grow fast and accelerate earnings rapidly. For instance, if you missed buying Infosys at ₹200 crore and later bought it at ₹500 crore, it hasn’t made much of a difference in the context of the company’s current market capitalisation.
You spoke of individual traits as an important aspect of 100-bagger investing. Could you elaborate on this?
More than the scientific approach of finding a multi-bagger, what is of relevance is that you should have a vision. Here, we are not talking about the management but about the investor’s own ability to comprehend the strength and potential of an idea. Vision is the biggest differentiator and it has nothing to do with education. The next trait you need is to have courage and conviction. Third, you need truckloads of patience. What is the typical holding period today? Once you have spotted a winner, you need to stick to it. The biggest mistake people make is selling promising stories in the middle of their journey.
Remember, while growth is mostly front-ended, money takes its time to accrue. Typically, a small company will tend to grow faster in the first few years, but share price appreciation or stock market return will happen at the later stage, when the margins, return and valuations — along with higher participation from institutional investors — start to reflect in the share price. To sum it up, a vision to comprehend, courage to buy and the patience to hold are the key individual traits that investors need to have to reap the 100X opportunity.