OLD ARTICLE – Original posted on September 1, 2014
A “ten bagger” is colloquial for a share price that rises a thousand percent or, in other words, makes you ten times your money. In some ways the Holy Grail of investments, the key consideration is how do you go about finding a ten bagger?
Firstly, you are never going to have a ten bagger if you sell your investment the moment you are up 10%, 20% or even 100%. The moment you exit the investment, you have given up the future upside of 990%, 980% or 900% respectively…
In other words, you have got to be invested into the position for a much longer time frame to enjoy the benefits of what is likely to be a multi-year run on a company’s share price driven by both growing profits and a re-rating in its valuation multiples (e.g. a Price Earnings re-rating upwards).
So, what are the attributes of a ten bagger?
The theory is simple: you are looking for shares in an undervalued, fast growing company. The more undervalued the shares are and the faster growing the company is, the better the investment probably is and the higher the odds are that the investment will achieve ten bagger status.
Sound simple?
Well it is and it isn’t. The complexity lies not in the theory, but in its execution.
It means that you are selecting shares fundamentally. You have to approach the market in a bottom-up manner, involving many hours of research on each and every stock with no guarantee that there are any ten baggers out there (sometimes, unfortunately, there is simply nothing worth investing in). You then need to build detailed forecasts, complex valuations models and, after all this work is done, you are still subject to market and asset-specific risk as you wait patiently for your investment to play out – and at the end of the day, you can still be wrong.
That said, here are some key attributes to consider when trying find a ten bagger:
- Good business, good investment, good odds of a ten bagger: In essence, a ten bagger is just a great investment into the equity of a great business. In the long-term, the better a business, the better the investment into its equity is likely to be. Thus, look for strong underlying fundamentals to the business, for example, profitability, cash generation, optimal debt levels, strong management, high barriers to entry, excellent competitive advantage, blue sky growth potential, and so on. This is not rocket science, but common sense research done thoroughly.
- Valuation: You make your returns on an investment when you buy. If you pay too much for a share, no matter how well the underlying business performs, you are unlikely to generate a fantastic return on your capital. Despite all their wonderful fundamentals, the early stage of a ten bagger investment tends to be one that is relatively ignored and unknown by the market. Hence, you can invest in the potential ten bagger share at a Price Earnings (PE) of, say, 5.0x that over the matter of five years when the profits have grown at 30% y/y and the share has re-rated to a PE of 15.0x will generate a price return of 1014% (Table 1)! This is a Cumulative Average Growth Rate (CAGR) of 62% per annum with c.30% being attributable to growing profits and c.30% attributable to the market re-rating the share’s valuation. Hence, you made 30% per annum choosing the right business to invest in and you made 30% per annum by not overpaying for that business upfront.
- The Base Effect: The larger a company becomes, the slower a company tends to grow. This generalisation is simple to understand – in a closed economy, a company can never logically grow larger than the economy, thus as it gets bigger and bigger, its growth rate slows down until it eventually just tracks the growth rate of the economy. As ten baggers are predominantly built on growth stories, this implies that ten baggers are likely to be found in the early stages of a company’s life. In the listed environment, this means that ten baggers will most likely be found amidst the small cap stocks.
Table: Ten Bagger Example
| Year | Company Profit | Growth in Company Profit (% y/y) | Price Earnings of Share | Investment Market Value | Return (%) |
| 0 | R 100 | 30% | 5.0x | R 500 | – |
| 1 | R 130 | 30% | 7.0x | R 910 | 82% |
| 2 | R 169 | 30% | 9.0x | R 1 521 | 204% |
| 3 | R 220 | 30% | 11.0x | R 2 417 | 383% |
| 4 | R 286 | 30% | 13.0x | R 3 713 | 643% |
| 5 | R 371 | 30% | 15.0x | R 5 569 | 1014% |
Theory always sounds great but the devil is in the execution. Most stocks invested into for their “ten bagger potential” will not end up being a ten bagger. That said, there is nothing wrong with a “9 bagger”, or “5 bagger”…or even just doubling your money.
Contrary to the beginning of this article, there is actually nothing sacred about ten baggers. Rather, they share the same characteristics as any other great investment and the diligent process of trying to find them will, at worst, likely result in you filling your portfolio with excellent stock picks.
And that is not the worst fate in the world…