(This article appears in Deccan Chronicle. Some editions today, some tomorrow. This article intends to set you thinking about big winners. And an approach that COULD work. Often, big wealth needs a bit of luck, but why not improve it with a lot of hard work? Put on your thinking caps.. Remember, do not put your nest egg or first savings in to this strategy. Do not get hurt

POST TAX RETURNS (CAGR) OF ASSET CLASSES
5- YEAR 10- YEAR 15- YEAR 20- YEAR
EQUITY 11.0 17.0 13.6 12.0
GOLD 9.0 12.9 11.0 8.4
BANK FD 5.7 5.2 5.1 5.5
PROPERTY 8.0 13.4 10.8 6.2
CAGR IN WPI 6.2 5.9 5.7 5.5
AVG INFLATION 7.4 6.3 5.9 5.7
(FIG IN %)

The above is from a  MORGAN STANLEY report that is more than a year old. There are several lessons or takeaways for us:

 

  1. Equities are the best weapons to fight inflation and bank deposits are the worst;
  2. Property is good, provided we are lucky with our choice. The above return is an ‘average’;
  3. Gold is neither as good as it is touted to be nor as bad as it seems.
  4. A return that measures the ‘average’ of a group or a set of products hides the real story.

 

We also have to factor in the point that the endpoints for these calculations were around December 2015. Thus, what the markets were at the beginning of the period have a lot to do with the answers.

 

There is one other interesting thing in these tables. The returns are ‘post tax’ returns. Now, given the fact that out of four asset classes covered above, three suffer income tax, the pre tax returns would tell a different story. Stock market gains are tax free if the holding period is more than one year. So, the pre tax and post tax returns would be the same (dividends excluded). However, there are different rates of taxation for different asset classes. Gold if bought as ETF would become a tax free return over long term, whereas physical gold would attract capital gains tax, identical to property. And in property, there are two choices.

 

The other thing is that you could invest a thousand rupees in the stock market or a gold ETF, but when it comes to properties, the minimum would be a greater number.

 

If I look at the above table, to me it looks like the differences between various asset classes are so thin, it makes one wonder whether it is worth taking so much pain and effort behind deploying one’s money.

 

To get the above returns in equities, you simply have to buy the index ETFs and sit back.

Most of us will spend our lives buying and selling stocks without any strategy. Luck will play a big role. However, we can improve our luck with some rational approach. I would keep scanning for opportunities. Buy them in small quantities, WITH MONEY I CAN WRITE OFF. And hold those stocks to eternity. If I can build a portfolio of around fifteen such stocks, and I get lucky, one or two of them could multiply over a hundred times in twenty years.

 

I will, for sake of simplicity, divide business in to two segments:-

B2B- these companies deal with other companies only. They supply some goods and services that go in to making some other produce for an end consumer. Could be an auto ancillary or a bulk drug making company etc. They should have some chance to grow at above the industry rate. A new entrant could start with a new product with one or two companies as his client and then expand his customer base. That would give the company an above industry growth.

B2C are companies that deal directly with consumers. They are subject to the whims and fancies of consumer preferences. It could be a bank (less vulnerable to changing preferences) or in fashion (very volatile) or technology providers (bursts of glory but long term could be shaky).

 

We can pick up the companies when they are very young (say less than 100 crores sales and just two three years young). If we make fifteen such picks, after doing some basic hygiene checks (nothing negative about promoter, manageable debt, no complaints on social media about product or service etc) we increase our chances of success.
The key factor behind our stock picks is our belief that:

  1. The product/service will attract demand and grow faster than industry over the next couple of decades;
  2. If in B2B space, they have some niche which will help them get more clients and grow big;
  • If in B2C, they have a product or a brand in which one can see a long term winner; and
  1. The promoter holding is strong (say above 60% ).

These kinds of companies will have good times and bad times. We should not get shaken off because of one or two bad years (unless we find that our story has totally changed or the promoter assessment was wrong or some business dynamics have changed permanently).

 

Building such a portfolio increases the possibility that we can find some of tomorrow’s business leaders. Once a company grows big and everyone starts following it, the stock becomes less of a multi bagger. It could give some timing related buying / selling opportunities.

 

It may not be a bad thing to have a five year review of each stock. The objective behind the review should be to check our initial assumptions. Progress may be and generally would be slower than we thought. If the basic assumptions are unchanged, there is no reason to dump the stock.

 

Over fifteen to twenty years, it is possible that one or at best two of the stocks could have become a serious wealth creator. Of the rest, a few would have gone bust and some would have given poor returns and some would have given better than average. The key thing to remember is that there is an equal or greater probability of losing a lot of money. If it bothers you, you should not take this route. For every success story we hear, there would be a hundred failures that weep silently.

 

R Balakrishnan

August 31, 2016

(The classification of business in to two groups is a simplistic approach and there are many paths one can tread. The motive is to ensure that you have a basic reason or assumptions when you buy a stock for the long term)

 

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5 thoughts on “THE ELUSIVE MULTI-BAGGER

  1. Thanks for this article Sir. If I run a screener for turnover less than 100 cr, promoter holding more than 60%, leverage of less than 1, I get a list of 445 companies (I could not apply the filter of a company being 2-3 year old). I have been trying hard to find stock ideas using filters like these.What other filters can we apply to contract the research universe and zero in on some say 20-30 companies to research..I approached a lot of fund managers, individual investors and most of them say that it’s the product and management that matters the most..However, as an individual retail small investor (with big dreams and aspirations), I have a list of 4000 stocks.If I apply too many fundamental filters then it’s high likely that the stock would already have been popular and would have given 5x type of return in the last 2-3 years..Request your views.

    Like

    1. Screeners will only be a starting point. You cannot pick a basket and sit back. Each one will have to be evaluated.
      And then, our expectations have to be met by the promoters. That is often the most difficult one to crack.
      If ROCE filter is set well, some business analysis should help to form a very short list. And one factor-
      Eliminate all commodity companies .

      Like

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