Here’s what separates multibaggers from the rest of the pack

*This is in partnership with BQ Prime BrandStudio

Ever since legendary investor Peter Lynch introduced the world to the term ‘10-bagger’ in his book ‘One Up on Wall Street’ in the 1980s, there have been debates galore on which stocks are multibaggers. But before we get into it, let’s understand what exactly a multibagger stock is.

An avid fan of baseball, Lynch used the term ‘10-bagger’ as a baseball equivalent of a dream-come-true—two home runs and a double. When referring to stocks, it meant a 10-fold increase in returns or an investment whose market price has grown 10 times its cost of acquisition in a relatively short span of time. Similarly, 20-baggers would be stocks whose value rises 20-fold. All these fall in the umbrella of ‘multibagger’ stocks, which have the potential of delivering manifold returns.

Traits of a multibagger

Multibaggers are essentially undervalued stocks of companies that have great fundamentals. While some such fundamentals—profit margins, earnings growth, cash flow and debt level are quantitative and measurable, a multibagger also has qualitative features like good governance, brand equity, as well as the research and development capabilities of a company.

Read on to know more about how to identify a multibagger stock.

1. High profit margins: Multibagger stocks tend to have little to no competition, which allows them to keep product prices high. Charging a premium means, they have higher profit margins. By dividing net profit by sales, one can calculate the net profit margin, and a general rule of thumb says that multibaggers will have profit margins more than 10 percent. However, one-time earnings from asset sales, etc., should always be deducted from net profit to get accurate profit margins.

2. High earnings growth: One of the main signs of a healthy company is high earnings growth. By calculating the earnings per share (EPS = net profit/number of shares outstanding), one can determine the growth rate. A higher EPS indicates a higher growth rate and hence, a potential multibagger.

3. High free cash flow: High free cash flow is a popular metric to judge a multibagger stock. Free cash flow is the cash remaining after deducting capital expenditure from operating cash flow, and it serves as the source of dividends, debt payments, capital for new business ventures, and expansion. Because cash flow is hard to manipulate, it gives a true picture of a company’s financials. However, even negative free cash flow isn’t bad if a company is spending capital on purchasing assets for business expansion, because there is future potential of cash generation from such assets.

4. Low debt levels: A low or zero debt level on the balance sheet indicates that a company can survive higher interest rates, a factor that has brought down many a business funded by debt. Debt-free companies usually make for sound investments and their stocks can be prospective multibaggers. Look at the debt-to-equity ratio, equal to total liabilities/shareholders equity. A low debt-to-equity ratio is desirable.

5. Good corporate governance: Good governance and a transparent, competent, and often conservative management ensure that growth is sustained, cash flow is high because waste is minimal, and everything from production and supply chain to finance and sales are efficient. Such companies have a great balance sheet and are potential multibaggers.

6. Research, development, and innovation: For companies to be successful and profitable in the long term requires quality products. Advanced research and product development facilities with constant innovation are key. Companies with such resources possess an edge over other players, thus potentially making them multibagger stocks.

7. Branding, patents, monopoly: Companies that enjoy greater trust or brand loyalty in the market can offer products at a premium (think Apple), ensuring higher profit margins. Similarly, companies with near monopolistic strength (such as Fevicol maker Pidilite) end up having a huge brand with little competition. Another feature is uniqueness of product that brands like Coca Cola have developed by patenting their product formula, something that cannot be replicated, ensuring a consistently high market share.

So, there you go—now, how many multibaggers are in your portfolio, and if not, why not head over to Groww and find some multibaggers.