Is it possible to get 9x returns through equity investments in 2-5 years ?
I haven't actually reverse engineered to find all stocks that increased over 900% in a 2 to 5 year period with an attempt to find patterns…though as I write this, it does'nt sounds like a bad idea at all...
Breaking the Myth
What kind of stocks do you think can give 9x returns?
I know, I know... most people do not think of 9x returns in the first place...
Come to think of it and the first thing that is likley to hit the mind is....ah, it's gotta be a micro or small cap stock...well, at least this is what I initially thought...
And after all the study, discussion and experiments with my mentor and partner in Investing, our first successful 10 bagger (actually 9 bagger to be precise) investment was Reliance Industries which was already the 2nd biggest company in the country by market cap at the time we invested…huh!
"Sum of parts is often more than the Total"In 2005, while the buy back was on amidst the brotherly dispute, there was huge underlying value in Reliance which in my opinion did not get reflected in the valuation. The thing that I really liked about the company was that every once in a while, one of the underlying businesses like telecom, energy, capital, retail etc under Reliance would mature and pop out.
Back then, my uncle used to describe Reliance Industries as:
"a hen that gave a golden egg once every 2-3 years !"If you got to have a healthy baby, you gotta nurture and feed it well, and so did Reliance use it's free cash flow to conceptualize, start and grow these businesses internally. For the first few years though, babies often need extra nourishment and affect the earnings (not the future earnings potential though). These babies were unseen/unvalued by the world (or the investor community so to say) hence resulting in a lower overall valuation of the consolidated business, than what would have been the valuation of the company standalone itself. These (perceivably unwanted) babies were huge businesses (blue chips) in the making, that were presently consuming cash and lowering the immediate profits.
If only one tried to see these businesses separately and value them 2-3 years forward, would he have seen the true underlying value…
Unfortunately (though for me, a blessing in disguise), most people have to be shown different pieces separately to be able to see the value… put them all in a box and they start valuing the box without knowing the contents.
To show it mathematically
- Business A makes a profit of 10 million on sales of 100 million and grows at 20% annually and is valued at 200 million
- Business B makes a loss of (3) million on sales of 50 million and grows at 30% annually and is valued at 100 million
Now imagine that these 2 businesses A and B are part of one single company AB and hence the consolidated results of company AB are shown as:
- Company AB makes a profit of 7 million on sales of 150 million and grows at 23% annually
As I said: "Sum of parts is often more than the Total"
Having said that, smaller companies are indeed more likely to fetch 10x returns for the reasons of the nature (Unless off course there is no limit on the market size and companies such as coke and Wal-Mart can find customers and favorably open retail stores on Venus, Mars and Jupiter)
(Start with Venus, I heard that women are from venus, so there must be a lot of craze for shopping out there too…)
While I usually restrict myself to look out only for consistently growing businesses that are ready for the next big leap...
Sure, you could get 10x returns in cyclic or commodity businesses too...
After all, every dog has a day, and when the demand-supply equation is favorable for a commodity business, it can certainly grow 10 times in a run up…most often eventually followed by a significant fall as the pendulum swings back or to say when the demand-supply equation turns back upside down, since these are cyclic after all...
Note: 10x returns need not always be the result of 10x growth in the business or underlying profits
10x means the market capitalization of a business becoming 10 times (or more than 10x if there is equity dilution and less than 10x if there is buy-back on the way...)
Now to explain this in a bottom-up or "per share" way:
Market Price of a Stock = EPS * P/E
(where P/E = Market Price / Earnings Per Share)
From my understanding and observation of successful 10 baggers so far, it is the multiplication factor of the enhancement in these two variables, that leads to 10x returns…
- EPS (Earnings per share) growing about 2 to 4 times in this period
- P/E growing 2 to 4 times in this period
EPS Growth
For a good business growing earnings at around 30% compounded annually, a 69% to 271% growth in about 2-5 years is not a surprise. After all, 100 * (1.3)^2 = 169 and 100 * (1.3)^5 = 371.29 (compound interest at work)
(Also, 100 * (1.3)^10 = 1378.58 !!!, so a business growing at 30% would be about 14 times in 10 years)
Price / Earning Growth
Among other things, P/E is often a result of market liquidity, investor confidence, growth potential, longevity, confidence in promoters etc…
At macro level, a bull run is very supportive in getting from x to 10x…
With one or more of the following factors: Lower interest rates, higher growth rate for economy, favorable and high ROI for businesses, high liquidity in markets, high investor participation in markets etc
It goes without saying, that 10x returns are mostly marked by a huge investor recognition for the business/stock leading the company's move from micro to small, small to medium or medium to large sized business.
The beauty of 10 bagger investing is that even if you have a horrible hit ratio of 10% (one in 10 stocks you pick grows 10 times) you would still be in good profits!However, with just a 10% hit ratio, the challenge would be in finding 10 potential candidates for the job...
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