One of the common reasons why many new investors are attracted to the share market is the lure of high returns.
After all, who doesn’t want to get rich fast by investing in a share that increases your original investment many times.
One of the initial terms used to refer to high-growth stocks was “10-bagger”. This term was coined by the legendary investor Peter Lynch to refer to shares that had multiplied the investor’s money 10 times the original investment amount.
But as Equity markets round the world continued to grow, we have moved beyond 10-baggers and now we search for 100-baggers.
After all, stocks that can grow your money 100 fold are definitely better wealth creators than stocks that grow your money 10 fold.
A related term used to refer to such stocks that can multiply your investment is “multibagger” and identifying a multi-bagger stock can help you grow your wealth fast. But how does one identify multibagger stocks?
High Growth + High Return on Capital Employed (ROCE)-
For a stock to turn multibagger, the company has to consistently grow its earnings at a high rate and has to achieve the same without deteriorating its returns on capital employed.
Growing Cash Flows
The cash flow of a company is the most accurate yardstick to assess a company’s performance. The cash flow statement determines the ability of the company to grow its earnings in the future. If the company isn’t able to generate cash from operations, it will have to repeatedly tap markets to raise money either in the form of debt or equity capital to grow its business.
Multibagger companies, apart from compounding profits, also consistently compound their operating cash flows (cash profit – incremental working capital) enabling them to grow at a fast pace year after year.
Companies that may perform well on the earnings and cash flow front but not on the growth front may be in a stagnant phase of their existence and hence might not earn returns for investors.
Prudent Allocation of Capital
Finally, we come to the point of prudent allocation of capital. As we now know, wealth creation is all about long-term compounding of earnings and cash flows. Companies that tick the above two criteria tend to generate huge amounts of cash and capital but how a company allocates that cash becomes the key differentiator between a good company and a great multibagger stock.
Sales and Profitability
Now this is an obvious trait.
If you take a close look at the world’s finest businesses, you’ll notice they have reported consistent and growing sales and profits over the years.
This is the second trait and an important one to look out when identifying high return stocks.
Market-cap
Finding multibagger stocks is no easy task. The listed universe comprises thousands of companies. Filtering out a select few from them is like finding needles in a haystack.
That is why you must have some criteria laid out to find these hidden gems. One such criteria is low market-cap.
Big companies are well known among investors. But they all started from scratch when they were trading at a low share price and a low market-cap.
While screening stocks, an important and obvious metric one should consider is to look at the company’s debt. Too much debt can sink a company.
In financial terms, leverage means the ratio of a company’s loan capital (debt) to the value of its ordinary shares (equity).
The two ratios to look at here are the debt-to-equity ratio and interest coverage ratio.
An important point to note is high level of debt alone cannot define the company’s ability to service it. There’s a good chance the companies with high debt can generate strong cash flows to service their interest cost and re-pay the debt comfortably.
Therefore, a better way to identify the risk is to check the interest coverage ratio. A higher coverage ratio is better, although it may vary from industry to industry.
Promoter Holding
The level of promoters’ shareholding is very important, especially in India where many businesses are family owned.
The shareholding level acts as an indicator about the confidence of the promoters in the business as well as the strength of leadership control in the company.
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