How do you find 100 baggers?
This is a tough question and one that does not have a definitive answer. If it did, we would all be multi-millionaires by now. Still, according to highly renowned value investor Mohnish Pabrai (Trades, Portfolio), finding a 100 bagger is easier if you look for companies falling into five key categories.
In a speech to students at Peking University in October 2016, Pabrai tried to dissect the topic of finding multi-baggers in the market. He highlighted five particular traits of multi-bagger stocks based on his experience of investing and studying Warren Buffett (Trades, Portfolio).
Over the next two articles, I'm going to try and round up these five criteria.
The Warren Buffett (Trades, Portfolio) criteria
"The first category of companies that has the potential for 10 to 100-baggers are businesses that have huge tailwinds. Tailwinds means they just have all the factors moving in their favor, they have very deep moats, they have very long runways,they have very high return on equity, they typically don't need any debt, and the most important condition, an idiot can run these companies. Like Warren Buffett (Trades, Portfolio) says, "Invest in businesses that an idiot can run because one day an idiot will run them." So which are the companies that a complete moron, stupid idiot can run? These are the businesses like See's Candy, Coca-Cola (KO, Financial), Moody's (MCO, Financial), Visa (V, Financial), Mastercard (MA, Financial), American Express (AXP, Financial)."
The first category is what I'm going to call the Warren Buffett (Trades, Portfolio) category.
These are companies that are already well-established, with well-known brands and a record of creating value for shareholders. These companies may not look like deep value investments when you first see them, but when you look to the long term, the possible returns are extraordinary.
Just look at the returns that Buffett has been able to achieve by investing in all of the five companies listed above. None of these businesses were particularly cheap when the Oracle of Omaha first began to build a position, but thanks to their ability to compound, Buffett was able to buy and still achieve outstanding returns.
Another great benefit of using this approach is that you do not have to spend as much time researching the opportunity compared to deep value contrarian stocks.
The benefits of good management
"That's the first one, the businesses that idiots can run. The second is exactly like the first except these cannot be run by idiots. These are businesses which are exactly like the first kind. They have huge tailwinds, they have deep moats, they have ultra-long runways, they have high ROE, they don't need any debt but they need great management, and they do have great management. These are businesses like Amazon (AMZN, Financial), Costco (COST, Financial), GEICO, Amorepacific, Kotak Mahindra bank - the one I bought in India which went up 60 times or something. Bluedart, which is the FedEx replica I bought in India. Satyam the IT company, then Restaurant Brands which is the one that owns Burger King and Tim Hortons (THI, Financial). McDonalds (MCD, Financial), Yum brands (YUM, Financial), Domino’s Pizza (DPZ, Financial). These are all great businesses but they do need solid management on top of them to make sure that they can keep those franchises. But these businesses have economics that are just phenomenal, just great economics."
Companies that fall into the second category are those with a robust business model that needs a skilled management team to be able to make it function properly.
There is some overlap here between the second and first categories. Great management can make bad companies good and good companies even better.
Unfortunately, for the average investor, it's difficult to figure out the quality of any company's management. Plenty of research is required. Even the best management teams can struggle to turn around terrible companies. Company culture should also be part of the consideration here.
Continued in part two.
Disclosure: The author owns no stock mentioned.
