multibagger stocks: How to identify future multibagger stocks? Here is a 3 step process

Every investor wants to have multibaggers in their portfolio, but finding such stocks is not easy. Mainly, there are three factors to consider when looking for these gems. The presence of all three is imperative if you are looking to identify long-term wealth creators in your portfolio. Let’s take a look below:

1) High Growth + High Return on Capital Employed (ROCE)
For a stock to become a multibagger, the company must constantly grow its profits at a high rate and must achieve the same result without deteriorating its returns on capital employed. The chart below highlights a few multibaggers that have consistently grown their revenue at a very high ROCE.


2) Growing cash flow
A company’s cash flow is the most accurate criterion for evaluating a company’s performance. The cash flow statement determines the company’s ability to increase profits in the future. If the company is unable to generate cash from its operations, it will have to repeatedly tap the markets to raise funds in the form of debt or equity to grow its business.

Multibagger companies, in addition to compounding profits, also systematically compound their operating cash flow (cash profit – additional working capital), allowing them to grow at a rapid rate year after year. Companies that may perform well on the earnings and cash flow front, but not on the growth front, may find themselves in a stagnant phase of their existence and therefore fail to generate returns for investors. .

Below are some companies that, despite being profitable in their core business (having a high ROCE), are unable to increase their cash flow to double digits.

multibagger stocks to buyAND CONTRIBUTORS

3) Prudent capital allocation
Finally, we come to the point of prudent capital allocation. As we now know, building wealth is all about building long-term earnings and cash flow. Companies that tick both of the above criteria tend to generate huge amounts of cash and capital, but how a company allocates that cash becomes the main differentiator between a good company and a great stock multibagger.

Below are some examples of companies that have prudently allocated their capital and generated incremental ROI above that of the base year.


Below are some examples of companies that have misallocated capital, generating additional ROCE that is lower than the base year ROCE.

stock multibaggerAND CONTRIBUTORS

We also noticed that companies that misallocated capital in the past and corrected their trajectory in the future saw their valuations/price performance also correct their trajectory.

  • Havells: In 2008, Havells India acquired Sylvania, a multinational larger than itself. Sylvania was making operational losses. The company had taken out loans to acquire the stake in the company. In 2015, Havells decided to sell 80% of Sylvania’s capital. From 2008 to 2015 Havells traded at an average PE multiple of 15x and after this announcement the stock was re-priced and has since traded at an average PE multiple of 35x.

  • Sundram Fasteners has restructured its international operations to maximize revenue potential and shareholder value.
sundaram fastenersAND CONTRIBUTORS

  • VRL Logistics withdrew its plan to operate a regional airline.

(Disclaimer: The information contained herein does not and does not constitute an offer to sell, a solicitation of an offer to buy, or an offer to buy any securities, nor should it be considered an offer or a solicitation of an offer, to buy or sell any investment product or service. Please consult your financial advisor before making any decision.)

(Sachin Shah is Fund Manager, Emkay Investment Managers Ltd and Nemish Shah is Research Analyst, Emkay Investment Managers Limited. Opinions are their own)

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