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How to identify a multi-bagger stock?

Author: Rajiv Singh/Wednesday, March 6, 2019/Categories: Exclusive

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How to identify a multi-bagger stock?

Trending across the social media is the #10YearChallenge. People are posting pictures of themselves from 10 years ago vis-à-vis their current pictures. We believe that the #10YearChallenge is important for investors too. We will look at the #10yearchallenge for stocks, but more importantly do a next ten years challenge.

If you invested Rs 10,000 in Wipro IPO in 1980, the invested wealth could now be worth Rs 703 crore: similarly Rs 10,000 in Infosys IPO in 1993 would be worth Rs 7.5 crore now. If one invested Rs 10,000 (Rs 1000 each) in the ten best-performing stocks in 2009 which are now part of Nifty 500, the accumulated wealth could be Rs 15 lakh.

India is the world’s fastest-growing major economy, and is expected to grow from USD 2.9 trillion to a USD 10 trillion economy by 2032. This growth should create significant opportunities for investors over the next ten years.

Identifying multi-baggers is both an art and a science. By following a structured and disciplined process, investors can identify stocks with a potential to deliver high returns. We believe that investors can find potential multi-baggers for the next 10 years by focusing on certain parameters, these are:

1) Explosive growth in discretionary consumption,

2) Growth stocks available at a reasonable price,

3) Companies under stress which may turn around,

4) Cyclical stocks at the bottom of the business cycle,

5) Undervalued companies 

6) New age industry disruptors.

Explosive growth in discretionary consumption

As disposable income of households grows, discretionary consumption is likely to grow exponentially.  Stocks like TTK Prestige, La Opala RG and Havells delivered multi-bagger returns during the last decade, benefiting from the increase in discretionary consumption and formalisation of the economy. Havells is an interesting multi-bagger story, the management excelled in allocating capital efficiently to high growth areas. We believe that Havells can deliver strong growth in the future as it is replicating similar strategy by entering into ACs, and kitchen appliances. Recent tax benefits will help consumption stocks as well.

High growth available at reasonable prices or GARP (Growth at a reasonable price)

While there are plenty of high growth and scalable stories, few are at a reasonable valuation. As a strategy, we recommend identifying high growth names and buying them when valuations are reasonable, typically during a correction. Buying Titan when the stock during demonetization resulted in wealth growing 2x.

We believe UPL (United Phosphorous Ltd), is a growth story at a reasonable price. Valuations at 18.7x are reasonable for a stock with 3-yr PAT CAGR of 28% and RoE of 25%. Acquisition of US-based Arysta Lifesciences could be a game changer for the company. The stock is a potential beneficiary from the rural focus of the government.

Companies under stress which are likely to turn around:

These types of situations can include companies under financial stress; these can turn around by changing their strategy, tweaking their business model or changes in their capital structure. HSCL (Himadri Speciality Chemicals) gave multi-bagger returns if one bought the stock when the company was under stress due to excess of dollar-denominated debt. The stock traded between Rs. 10 and Rs. 20 for a long time; however, as its financial performance turned around, the stock gave 10x returns over the last three years.

Federal Bank is under stress, but has long term potential. With an ROE of 10.5% and P/BV of 1.3x the stock is attractive, Net NPA at 1.72% is low and with Tier 1 CAR (Capital Adequacy Ratio) of 12.3% the bank can grow its loan book without significant equity dilution. The new management is taking the right steps, and its performance is likely to improve.

Cyclical stocks

Cyclical stocks may be a multi bagger, if bought at the bottom of the cycle. Stocks like HEG and Graphite gave 40x returns from the bottom of the cycle. Commodity stocks like JSW steel or capex related stocks like VA Tech Wabag can deliver multi-bagger returns if entered during the low point of the business cycle.

Undervalued Stocks

An undervalued relative to its growth potential can be a multi bagger as the stock may be mispriced on account of problems temporary in nature, as the concerns fade, the stock can re-rate.

One can consider Advanced Enzymes Technologies, which manufactures enzymes which find applications for human healthcare, animal healthcare and food processing.  The market is concerned about its concentration risk and promoters having pledged 27% of their equity. Currently, the stock trades at a PE of 17x which is low given its high margin (60-70% operating margin) and growth potential and high entry barriers, and we believe it has re-rating potential.

New age industry disruptors

Disruptors are those who disrupt the existing business model using technology or other competitive advantages to benefit from the inefficiencies of the incumbents. It is hard to find disruptors in the listed space; Bajaj Finance has been a disruptor.

The company disrupted the consumer finance business in India with an innovative concept of offering customers pre-sanctioned zero interest EMI cards. The stock has stock has multiplied 3.5x times in the past 3-years and 430x over 10 years.

We believe All Cargo Logistics has the potential to disrupt the logistics sector; its subsidiary ECU Worldwide wants to be the “Uber” for the business of booking marine freight, given its end-to-end connectivity across the globe. While there are constraints, the company can potentially overcome them using technology, giving it the potential to disrupt the sector and generate multi-bagger returns.

In conclusion, identifying stocks with potential for wealth multiplication maybe hard, but it is not impossible. We might not have a crystal ball, but we have attempted to outline the framework which can help investors identify high growth stocks. Investors have to ride out volatility, and hold the stock for the long term to build wealth. While our list is not exhaustive, investors can benefit from the approach and stocks we have highlighted.

The author is CEO of Karvy Stock Broking

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The technical studies / analysis discussed here can be at odds with our fundamental views / analysis. The information and views presented in this report are prepared by Karvy Consultants Limited. The information contained herein is based on our analysis and upon sources that we consider reliable. We, however, do not vouch for the accuracy or the completeness thereof. This material is for personal information and we are not responsible for any loss incurred based upon it. The investments discussed or recommended in this report may not be suitable for all investors. Investors must make their own investment decisions based on their specific investment objectives and financial position and using such independent advice, as they believe necessary. While acting upon any information or analysis mentioned in this report, investors may please note that neither Karvy nor Karvy Consultants nor any person connected with any associate companies of Karvy accepts any liability arising from the use of this information and views mentioned in this document. The author, directors and other employees of Karvy and its affiliates may hold long or short positions in the above mentioned companies from time to time. Every employee of Karvy and its associate companies is required to disclose his/her individual stock holdings and details of trades, if any, that they undertake. The team rendering corporate analysis and investment recommendations are restricted in purchasing/selling of shares or other securities till such a time this recommendation has either been displayed or has been forwarded to clients of Karvy. All employees are further restricted to place orders only through Karvy Consultants Ltd. This report is intended for a restricted audience and we are not soliciting any action based on it. Neither the information nor any opinion expressed herein constitutes an offer or an invitation to make an offer, to buy or sell any securities, or any options, futures or other derivatives related to such securities.

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