Why Your Focus On Multibaggers Is Sabotaging Your Returns

The world of investing seems to be enamoured with multibagger stocks that promise booming returns in very short time. We all hear stories of “someone “ who has made 10-20-40-even 100x on a particular stock in double quick time. In an age where greed knows no limits, it seems n ovice investors want their every stock to be a multibagger. The problem is further accentuated because of those investment legends of how 1000 bucks invested in Infosys would have turned into few hundred crores in two decades. The recent stars like Titan, Page Industries, Eicher Motors and TTK prestige have further got the imagination of many investors soaring thereby compounding the problem. Problem? Yes, we call this a problem because it is this very focus on multibaggers that may be harming your portfolio return. Before it gets really confusing let us make our points backed by sound logic and facts!

On a limb and a prayer

 For any investment to turn into a multibagger, two things should happen; One, the earnings of the company have to grow rapidly and two, massive PE expansion has to occur. Hence, you should be able to identify a stock early enough for the fast growth to play out over a few years and the valuations have to be cheap. Now you can find fast growing companies but more often than not the fast growth is already reflected in the price. When choosing between the trade off between growth and valuation most investors err by choosing growth .This is where the problem lies.

Investors buy highly priced companies hoping that the growth will go on forever and the PE will expand further. Neither of the scenarios plays out as desired.  You can’t expect to make money buying a high-flying stock at PE of 39+, period! Buying a richly priced stock looking at its recent growth is perhaps the worst way to invest and it often leads to spectacularly bad results.  It is like praying for Gods to smile on you just because you choose to be rich. This is why one needs to identify a mid cap or small cap stock which has a potential of becoming a large cap and this requires a great deal of research and analysis.

High risks, Lower returns

 In their chase for multibaggers, investors buy stocks that are the darlings of the market. They seldom do a thorough due diligence. In their eagerness not to be left out, they end up buying stocks with questionable management or highly priced stocks with no margin of safety. The example we gave above of stock at 39+ PE? That was Kitex garments, touted as the next Page Industries…and many investors lost heavily.

 Another example is Opto Circuits, twice listed in Forbes best under a billion companies list, with years of great returns and an absolute favourite of the markets. Investors failed to notice the unusually high receivables of more than 35% of sales and when this news came out the stock tanked and lost a whopping 85% of its value! One more example: ICSA India was being asserted as the next Infosys by many market pundits which became another classic example of “How investors lose when they invest in a company run by not so honest management”. In the world of investments high-risk leading to high-return is not a case always.

Can you love an ugly duckling…..and can you identify one?

 Most multibaggers of today were the ugly ducklings of yester years. Infosys IPO was a spectacular failure, Hawkins hovered at 15 bucks for 5 years before turning into a 100 bagger in the next decade, Titan was down the dumps and BHEL an investors pariah before turning a 50 baggers from 2001- 2007. Finding a multibagger requires extreme patience and thick skin to go against the opinion of the majority and requires an extremely wide horizon. Few investors have these three in ample amounts. Alternatively, quite a few investors get into beaten down stocks hoping that every ugly duckling will turn into a beautiful swan. Stocks prices go down for a reason and can remain low for extended periods of time. Both the strategies of taking huge contra bets as well as momentum buys are rife with risk and the risk reward ratio is more skewed towards risk than rewards.

So What is the Alternative?

Steady compounders. That’s the alternative. Buy great companies that are growing steadily and have honest management and are at decent prices and hold on to them for as long as you can. More often than not, they will turn into multibaggers. The table below illustrates the point convincingly. At a rate of 15% CAGR, a stock turns a 3.5 bagger in ten years, at 18% it’s a 4.4 bagger and at 25%, a 7.5 bagger!! All this with an assumption of there being no PE expansion and the stock being held for 10 long years. Boring? Absolutely! Lacking much work? Totally! Glamorous way of making money? Hell no! Yet this is the most effective and easiest strategy to ensure long term growth and beat over 95% all professional fund managers in the game of investing.

returns of a steady compounder

returns of a steady compounder

Alas, most investors don’t follow this strategy. Why? Because it forces you to be patient, it makes you do nothing when the prime instinct of many investors is to be busy “playing the market”. It makes you focussed and be patient and not follow the crowd. Not too easy to miss the next “big thing” on the street for a company that is growing at a “slow” rate of just 15-18%. This is where the men are separated from boys in the world of investing. Our didactic tone notwithstanding, is the character that ensures long term success in the stock market not information edge. Success in the world of stock Investments is never based on smile of gods but on having enough margin of safety so that you don’t lose much even if the Gods don’t smile.