Characteristics Of Multi-baggers

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Back when I first started my journey on picking stocks, I stumbled upon this book called "100 baggers" by Christopher Mayer. This book changed the way I look at investing and inspired me to embark on my own journey to seek out multi-baggers myself and hopefully - a 100 bagger.

As we approach December and the end of the year, I had some time to reflect on my personal finance journey so far. I took some time off to look at my watchlist of stocks, to identify the common traits I see in multi-baggers, and update any new traits that I discover into my investment framework.

What are multi-baggers? Multi-baggers are stocks that have given returns that are several times their costs. Here are the most important characteristics in my opinion, in the making of a multi-bagger, some of which have been highlighted in Christopher's book.

1) A large and growing total addressable market

Image source: Unsplash

Having a large and growing total addressable market is essential because even if the company has many competitors, there is still room for it to grow because the total amount of market share available to capture increases over time. Furthermore, in the worst-case scenario, even if the company fails to become the dominant player, being the 2nd biggest or 3rd biggest will still be fine because the absolute size of the market share captured is still going to be significant.

Generally, for the total addressable market to keep growing, the company's products or services have to be part of a secular trend. Citing Sea Limited as an example, gaming, digital payments, and e-commerce are all part of secular trends of online consumption. Moreover, E-commerce as a percentage of retail sales in Southeast Asia is still low compared to more digitally enabled economies such as China and the United States. This suggests that e-commerce penetration is still low within Southeast Asia and there is still a long run-way of growth.

Some other ways in which the total addressable market can grow would be by venturing into new businesses or expanding into new countries.

2) Owner-operator and holding a significant percentage of shares in the company

GIF source: Tenor

Christopher Mayer cites this as having "skin in the game" in his book. To simplify things, the reason why management holding significant equity is imperative is that it means it is in the management's interest to ensure that share price appreciates because it is tied to their personal net worth. If the share price drops, the management will lose significant amounts of their wealth as well.

This alignment of interest with shareholders guides decision-making processes and will ensure that business decisions are made in the best interests of shareholders. For instance, it could mean investing in sales and marketing now to acquire customers before heavy monetization instead of being profitable now with a small customer base.

To find out the shareholdings of major directors, I normally look up the DEF14A filing in the SEC filings by the company. An example of the DEF14A for Crowdstrike:

Image source: DEF14A of Crowdstrike, dated (May 14, 2021)

Being an Owner-operator is an essential trait that I look out for as well, simply because almost all founders start a company to solve a problem and there is normally a major "why" - the company's reason to exist. The founders probably have gone through many obstacles to reach the stage of being a public company and understand the business the best. Hence, if they are the operators, they would be able to make the best decisions for the company.

For instance, George Kurtz - the CEO and co-founder of Crowdstrike, founded the company because he was frustrated at the existing security technology that was being too slow and not being able to adequately protect the user. He cites that watching a passenger on a flight wait 15 minutes for McAfee to load on his laptop inspired him to start Crowdstrike.

3) Having a moat or an edge that can put competitors out of reach from you

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The term "moat" was popularized by Warren Buffet, which is a means of maintaining competitive advantages over competitors to protect long-term profits and market share. A moat can usually lead to increased pricing power for a company.

Having a moat can come in several forms:

(i) Being the dominant player:

Image source: Feedvisor, The amazon flywheel explained

This is generally important for marketplace businesses such as Amazon, Shopee of Sea Group, Etsy, and Fiverr. Being the biggest means having a continuous virtuous flywheel effect that can be unstoppable once it starts. The flywheel effect starts out by onboarding a decent enough number of Merchants onto the platform in order to sell their items. Subsequently, it's to offer discounts or free shipping to onboard more customers onto the platform to buy the items. More customers will attract more sellers and this will lead to a wider selection which will attract even more customers. The flywheel repeats and continues to spin continuously, creating huge momentum for the business.

(ii) Having a strong brand:

Image source: Unsplash

Every time we think of soft drinks, coca-cola comes into mind, and the brand is so strong that almost everyone knows of it. Similarly, this can be seen in Monster Beverages' energy drinks and Celcius Holdings drinks as well. Having a lasting image in consumers' minds will ensure recurring purchases and brand durability.

(iii) Having a high switching cost:

GIF source: Tenor

If it's going to take a lot of effort to switch to another competitor's product or service, consumers will be less willing to switch. For Crowdstrike, the ease of onboarding reduces friction for new customers to try out the software. The software is lightweight and provides better protection. This reduces the switching cost for new customers and increases switching costs for existing customers of Crowdstrike, making the product "stickier". Customers that have gone on to adopt cloud infrastructure will not want to go back to legacy on-premise security software.

(iv) Network Effects:

Image source: Unsplash

One prime example is Microsoft. For years, everybody is using its operating system, and so you wanted to use its operating system too. Similarly, this is seen in the earlier years of Facebook and now Instagram. Everyone is on this social network, and so you also want to be on the network too. 1 leads to 10, 10 leads to 100 and this continues exponentially...

This is one of the primary reasons in my opinion, why big tech companies are in a race to create the metaverse, which can also be seen as the next big platform for people to connect. Whoever moves first and manages to create the next big platform, will enjoy the network effects and therefore become even stronger.

(v) Doing things cheaper than anyone else:

GIF source: Tenor

A prime example is Costco, which relies on economies of scale to ensure that items are the cheapest as possible compared to other retailers. Costco has a membership structure for its customers, where customers will seek to spend more to "earn" back the membership fees from savings on items. This drives demand for which leads to more purchases with suppliers where they will gain an economy of scale and be able to get the items at a lower price. They then pass on the cost savings to customers and the cycle repeats. This allowed Costco to grow much faster than its competitors.

4) Growing at a fast rate and the size of the company is still small

Image source: Corporate Finance Institute (CFI)

Every company started small. Every big company out there was a startup once. As an investor, if we want to be rewarded with extraordinary returns from multi-baggers, we have to take part in their growth journey as they go from 0 to 1. In particular, ideally, we would want to be part of the company's journey during the middle of the "S" curve as seen in the picture above.

Furthermore, it would be easier to go from a 500 million market cap to a 1 billion market cap compared to a 1 Trillion market cap to a 2 trillion market cap. Having a small base will matter if we want outsized returns because the absolute amount needed to grow 2x or even more will not be as much compared to larger caps.

5) Revenue is of high quality

Image source: Unsplash

Not all businesses are created equal. Some business models are inherently better. Similarly, revenue streams are not created equal. These are some of the questions I ask myself immediately when I look at a business.

1. Is the revenue recurring or one-off? Recurring revenue suggests predictability and valuations tend to be higher because the revenue is of higher quality.
2. What are the margins like for each dollar of revenue? (It's not about how much you make, it's how much you can keep.) For instance, software companies normally enjoy high margins and the marginal costs of creating another unit of software are close to 0, which leads to operating leverage.
3. Is the revenue source for the company diversified or concentrated? If it's concentrated on one customer or one product alone it can be seen as riskier which leads to a lower valuation.

Some concluding thoughts:

Based on John Boggle's formula, returns are driven primarily by 3 factors, primarily dividend yields, earnings growth, and multiple expansion(valuation). Most of the companies that I have highlighted here as examples do not have dividends, hence earnings growth and multiple expansion are the two core engines that drive returns for investors. All the factors above have an impact on these two engines in some way or another, which is why I believe multi-baggers have these common traits.

Of course, identifying multi-baggers via these traits and buying into them isn't sufficient, as we must have the correct long-term mindset of business owners to hold them through periods of volatility as well. Patience is equally important. I think Thomas Phelps's quote sums it up pretty succinctly:

"Have the vision to see, courage to buy, and patience to hold. Patience is the rarest of the three."

I hope that you enjoyed this article and that it has added value to you in some way or another!

Disclaimer:

The above article is solely my opinion and for informational purposes only. The information presented in the article should not be taken as investment and business advice. In fact, the information presented should not be seen as advice for anything. The information presented is not a recommendation to do anything as well, be it buying or selling any investments. Please do carry out your own due diligence before making any financial decision or seek a certified financial advisor if necessary.

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Cover image source: Unsplash