What are multi-bagger stocks and how can they improve your portfolio?

A multi-bagger stock is hard to define but you can surely make out if you see one. Take some obvious examples in the last many years.

Feb 02, 2019 01:02 IST India Infoline News Service

A multi-bagger stock is hard to define but you can surely make out if you see one.

Take some obvious examples in the last many years. If you had invested Rs10,000 in Wipro in 1980, then that investment after considering all the splits and bonuses would be worth Rs600cr at the current market price, with no additional effort from your side. We are not even counting the Rs2cr that you will be earning as dividends each year.

Had you invested Rs1 lakh in Havells in 1996, it would be worth nearly Rs35cr today. For that matter, Eicher was quoting at Rs200 in 2009 after the Lehman crisis. Exactly 9 years after the crisis, Eicher had touched Rs33,000. A south based name like TTK Prestige was struggling to cross Rs100 in 2007. By 2017, it had touched Rs9000.

If you look at some lesser know names like Tasty Bites, Symphony, Natco Pharma, or Ajanta Pharma in the last 10 years, these have been multi-bagger many times over. So what is it that creates a multi-bagger?
 
What creates a multi-bagger stock?
  • While it is hard to pin point a single factor that makes a multi-bagger, there are a few basic points to note. Most multi-baggers have some or all of these merits in them.
  • They have a disruptive product or a disruptive idea in the market. Hero Moto introduced fuel-efficient motorcycles which were a disruptive idea in the 1980s. Apple introduced the smartphone, which changed the mobile industry forever. Hence the value.
  • An ability to scale up quickly is at the core of becoming a multi-bagger. In the mid to late 1990s, when Infosys and Wipro demonstrated their ability to scale up rapidly ahead of the Y2K challenge, that was when they became multi-baggers.
  • Creation of a moat in the form of some entry barriers. Britannia became a multi-bagger by creating a moat around its premium biscuits segment. HDFC Bank almost created a moat in retail banking. No doubt they became multi-baggers over time.
  • Low appetite for capital is the key to big returns. If you see some of the multi-baggers in the last 20 years, they have been frugal in the use of debt and equity on their balance sheet. Even with the previous 3 advantages, if the capital base becomes bloated, then forget about being multi-baggers. Infrastructure companies have destroyed value in the last 10 years purely due to their bloated balance sheets.

Why do we need multi-baggers in our portfolio?
Multi-baggers are a great story to tell but that is just the more romantic side of it. Multi-baggers are important for some key reasons.
Even the best of investors do not get all their calls right. In fact, they do not even get most of their investments bang on target. There are about 30% underperformers, 50% market performers 15% outperformers and just about 5% multi-baggers. With this kind of a mix, most portfolios are going to underperform the market. The only answer is to make the most of your multi-baggers. Getting into Titan at Rs.100 in 2005 and exiting at twice the price after a year is not great news. It is only when you create a 50-bagger in 10 years that you really have a multi-bagger story to tell. It compensates for the scores of laggards and tepid performers in your portfolio.

A single multi bagger can make a big difference to your portfolio returns. Just check out the table below of a portfolio of 5 stocks:
Details Stock A Stock B Stock C Stock D Stock E
Outlay Rs10 lakh Rs10 lakh Rs10 lakh Rs10 lakh Rs10 lakh
CAGR Returns 14% 14% 14% 14% 14%
Value after 5 years Rs19.25 lakh Rs19.25 lakh Rs19.25 lakh Rs19.25 lakh Rs19.25 lakh
Value of the overall portfolio after 5 years Rs96.25 lakh
Now replace Stock E with a Multi-bagger stock with is a 7 bagger in 5 years
Outlay Rs10 lakh Rs10 lakh Rs10 lakh Rs10 lakh Rs10 lakh
CAGR Returns 14% 14% 14% 14% 7 bagger in 5 years
Value after 5 years Rs19.25 lakh Rs19.25 lakh Rs19.25 lakh Rs19.25 lakh Rs70.00 lakh
Value of the overall portfolio after 5 years Rs147 lakh
 
In the first case, when all stocks were market performers, the CAGR yield of the portfolio was 14% per annum. When you just replaced one stock with a multi-bagger (7 times in 5 years), the average CAGR yield of the portfolio goes up sharply from 14% to 24.08% and makes a big difference to the eventual wealth created. That is the power that multi-baggers wield.
 
Finally, multi-baggers in your portfolio also improve your risk capacity. In a portfolio of 20 stocks, if you have even 2-3 multi-baggers, then you have the leeway to wait longer for the other stocks to perform. Time works in your favour in this case.

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