As mentioned in my premium room I am fully invested and used quite some margin. Hence, while I am not trading, I am focusing on self-education and am working on building a more formal strategy that I plan to share in the next couple of weeks.
I have just finished reading 100 Baggers: Stocks that Return 100-to-1 and How to Find Them by Christopher W Mayer. The book resonated with me, as it somewhat aligns with my investment strategy.
In this book, Christopher W Mayer describes some principles of finding the next 100-bagger. To do so he did an analysis of 365 stocks that turned $10,000 investment into $1,000,000 between 1962 and 2014. His study only included stocks that had an original market cap of above $50 million. It also only included stocks that a person might have predicted will become a 100-bagger, meaning it excluded gamble-like stocks in oil, gold exploration, and biotech developing a major drug. If a company strikes gold or oil or gets lucky to develop a new important drug, it may turn into a 100-bagger, but this is more of a gamble and was not good for Christopher's study. He wanted to focus on stocks where an investor had the means to see the stock may turn into a 100-bagger.
Here are key concepts and principles that Christopher W Mayer developed by looking at all those stocks that became 100-baggers. These are high level and I still recommend reading the full book as it is an easy and interesting read full of interesting cases.
The most important principle is to find the right stock and hold tight to it for many years.
By the right stock, Christopher means companies that:
Have a high return on capital (above 20% ROE)
Ability to reinvest the earned capital and continue to have above 20% ROE for years and years.
Have great management that cares about shareholders and growing value per share.
Principle #1: You have to look for them.
It is difficult to find them, you might need to go through 100 companies to find one that might show enough strength and potential to become the next 100-bagger. When looking for the next 100-bagger, be not tempted to shoot at anything small. Don't waste time and your mental bandwidth that have no chance to hit that status.
Principle #2: Look for the stocks that can grow perpetually
You need to look for businesses that have a lot of growth. A rule of thumb is to look at the companies that can grow revenues and value at 10%+ for many years ahead. You want value-added growth. If the company double sales, but also double its number of outstanding shares, this is not good. You want a good balance of both revenue and EPS growth. However, there are quite a few 100-baggers that grew sales like crazy but did not grow earnings as much (Amazon is one of them).
Principle #3: Lower PE multiples preferred.
First, you don't want to pay stupid prices. Let's say you pay 50 times earnings for a company. To become a 100-bagger in 10-20 years you need to expect that this multiple will remain. If the multiple drops to 25 you would need the company to grow 200 times in earnings. On the other hand, Christopher shows how many current 100-baggers started trading at very low PE multiples of 3 to 5. At that time, these companies were out of favor. However, once they started growing the PE multiple for them increases to 20, sometimes 30. Here is an example. Let's say you buy a stock that currently trades at a PE of 5. Later, the company starts growing sales, investors now have a different valuation for the stock and give it a PE of 20. This means the earnings would have to grow only 25 times for the stock to become a 100-bagger. If the stock was originally trading at a PE of 20 when you bought it and it continued to have such PE when you sold it you would need to expect earnings to grow 100 times.
However, this is a bit of a grey area. Sometimes the business grows so quickly that you may be OK paying higher premiums for its stock (higher PE). Here, you need to look at the earnings growth and see if the current PE makes sense. Let's say a company currently trades at a PE of 50 but is expected to double its earnings in 2 years. This would mean in 2 years, PE would be 25.
Principle #4: Economic moats are necessary.
Generally, you would want to own a company that has some ways to protect its growth in sales and the price for its products against the competition to make sure it continues to grow.
Principle #5: Smaller companies are preferred
Apple or Google is a great business to own, but the chances of these companies to grow 100 times in the next 20 years are close to 0. On the other hand, you should not assume you need to go for microcaps or penny stocks. The median sales for the 365 companies (before they started to grow) in Christopher's study was $170 million. He suggests focusing on the companies with market caps of less than $1 billion.
Principle #6: Owner-operator companies are preferred
Christopher discusses how many of the best companies are started by visionary owners and CEOs who have a stake in the business and are really focused on growing their equity through growing share prices. They are less interested in short-term fluctuations, think big and long, are not impacted by quarter performance bonuses. However, there were some companies that were not operated by owners but still performed well.
Principle #7: You need time
It takes a long time for a stock to grow 100 times. Let's say a company grows earnings at a rate of 30% per year (which is very aggressive for the long-term). This means if the company makes $1 million this year and invests it into its operations/acquisitions it makes $1.3 million the next year, $1.69 the next, and so on. It will take the company 18 years to increase its earnings 100 times. In Christopher's study, there are many companies, some were able to get to 100 times in as early as 8 years, but this usually happens when the companies start trading at a low PE multiplier which later grows. There are also plenty of examples of stocks that took longer to grow but grew at multiples of above 100 (200, 300, even 1000-baggers).
Principle #8: You need a good filter for the clutter of information.
You need to focus only on the information about the business you invested in and any factors that can forever affect its ability to grow earnings. Information about interest rates, inflation, the federal reserve is useless.
Don't follow quarterly earnings, even a year may not be good enough. It is more important to focus on earnings power, meaning does anything really change about the company that prevents it from restoring earnings in the years ahead (very often companies are affected in the short-term by economic factors, but maintain their moat, client base, etc.)
If you trust you researched well the business you are in and they continue to grow you don't need stop-losses. Christopher brings up an example of Monster Beverage Corp. which is a 1000-bagger over the past 20 years, and which had many months when its stock price dropped 20 or more percent. Haven't you put stop-losses, you would miss a lot of that growth. Also, watching the stock price on a daily basis is a bad thing as you are tempted to sell in times like above.
Principle #9: Bad things happen.
You could do all the work right, and then some new innovation comes along and crosses your company's moat and ability to grow earnings. This is likely the only time you need to sell your stock.
Principle #10: You should be a reluctant seller.
Some of the reasons that you should never sell for (according to Christopher):
My stock is too high.
I need capitalized gains to offset my losses for tax purposes
My stock is not moving.
Personally, I somewhat disagree with number 1 above. I have seen stock prices shoot so quickly that valuations get crazy. E.g. stock is trading at a PE so high, it would take it 10 years to grow earnings to get to a more fair PE. I sometimes sell stocks in such cases.
Some other great ideas I found in this book:
It is OK to concentrate if you strongly believe in the company. Christopher states how many of the investors he knows do just that and are very comfortable with 50% of their portfolio in just 5-10 stocks.
Dividents are generally not that good. We usually want to look for the companies that are hungry for cash they generate as they have a lot of things to invest in: expanding operations, acquisitions. You want to see the management invest that money they make and make even more money on this invested money (at ROE above 20%). If the company pays dividends, it has less cash to invest in growing operations. However, Christopher says there are plenty of companies among the 100-baggers that pay dividends, but usually, you want the companies that have low payouts.
Christopher (and Warren Buffet) favor the companies that buy back their shares in times when they have no ideas for expanding business or acquisition. Retiring shares means there are fewer of them available and EPS per share increases.
People often do dumb things to their portfolios because they are bored. This one I particularly liked. Sometimes I feel an urge to sell something because I feel bored. I feel great about selling something at profit and want to experience that joy. This is wrong. The key rule is to find great companies and sit tight.
A very good read to my mind. It also provides some references to other books that I now plan to read. I really like the concept and plan to use it to search for great stocks. However, I am not sure I will have it in me to wait 18-25 years to arrive at a 100-bagger.