Common complaint of the elder generation, ‘those were good old times’ is rightly criticized for its blanket debunking of the present in favor of the past seen through nostalgia tinted glasses. The world has indeed become better in a lot of ways. But the applicability of this adage in stock market is totally apt.
In ‘good old days’ when there was lower research-based participation in the equity markets, multibaggers were aplenty. There were juicy low hanging fruits ready to be plucked by anyone with reasonable smarts and patience. But with so many intelligent investors (both institutional and individual) combing through the markets with a lens, easy opportunities have all but disappeared. It is not that there are no quality stocks left, if anything there are more of them than ever. It is just that they have been bid up so high that fat returns are not left in them anymore.
But all is not lost. There are still ways to make superior, and with luck, multibagger returns. A few such opportunities are listed below: –
1) Emotional opportunities
There are times when panic rules the market and good companies are available at very cheap prices. These are moments when one rupee can be purchased for fifty paise. A few examples of this type of situation are – the panic created after financial meltdown in 2008, sharp decline after demonetization, Covid induced crash, etc. Such events seem to be happening more frequently now than in the past providing rational and patient investors opportunities to create a lifetime of wealth in a short time.
But it is not easy to buy in these circumstances with every gut in the stomach screaming end of the world. What helps in investing during such times is holding on to the rational thought that if everything indeed will get destroyed then bank FD’s and other investments too shall become worthless. However, prudence and peace of mind demands investing only that sum of money whose loss can be afforded without much impact.
2) Quality stock opportunities
In this hyperly researched market, quality stocks will not be cheap on valuations. But generally, market underprices high growth. Hence quality companies having confluence of good management, high return on equity (ROE) and high growth for a foreseeably long time can be bought in the starting phase of their growth. If growth continues at a higher rate or for a period longer than what market expects, extraordinary returns can be had even when bought at high PE ratios. Recent examples of such stocks are D Mart, Dixon, Tata Elxsi etc.
Once growth starts to taper, there is huge price or time correction. Hence the importance of entering such highly priced companies in the initial phase of high growth cannot be overemphasized.
3) Beaten down but not dead companies
Every sector, every industry moves through cycles of up and down. The length and severity of the cycle differ from industry to industry. But the pattern is the same. Demand soars leading to scarcity thereby pushing product prices higher resulting in higher corporate profits. This is followed by the expansion of capacities by companies leading to lower prices because of a glut in the market resulting in lower corporate profits. During downcycle of an industry, all companies, good or bad get beaten down and many of them die. But the surviving companies and their investors rake in huge profits when the upcycle inevitably comes.
There are three main characteristics for identifying and profiting from such opportunities.
First is that the industry that they belong to must hold perennial relevance. Products like steel, cement, autos, sugar, FMCG, white goods, etc will always be required but you would not want to buy a company making carbon paper in times of digital documents no matter how cheap it is!
Second is that the company should be amongst the leaders, be the lowest cost producer and preferably have nil debt because that will ensure it never dies.
And finally, it is about the timing of buying and selling. These companies have to be bought when their industry is going through crises and weaker companies are folding up. After having bought them, there is nothing to do but wait. When the external environment changes, the survivors become thrivers and start making money hand over fist. This is the time to get off them in search for some other industry in distress.
This strategy can be given many names like contrarian investing, value investing, cyclical investing, etc. But rightly executed, it can lead to extraordinary returns.
4) Small and Midcap universe
Institutional investors generally stay away from these stocks which leaves this universe largely unexplored. Some ingredients of multibagger stocks like high ROE, low debt, high past growth can be found in many small and midcap stocks.
Continuation of high growth for a reasonably long period of time is also an essential ingredient for superior return. Since the future is always uncertain, this remains a risk for all companies. However, this risk can be mitigated to some extent by sticking to market leaders with industry tailwinds.
But nothing is ever easy especially making above average returns in small and mid-cap stocks.
The first pitfall in this class of stocks is of untested management. A less ethical or less capable management can destroy value leading to permanent losses for the investor. There are many scuttlebutt strategies to evaluate the management which can be discussed later but none are foolproof. Satisfaction with quality of management is critical for success in this segment.
The second pitfall is to avoid companies operating in industries which have small TAM (total addressable market) like let’s say company making simple calculators when these are available in all mobile phones. Such companies cannot grow after a few years despite being leaders in their industry and having the best of management.
The aforesaid are by no means exhaustive or the only ways. There are so many roads and routes to the same destination of wealth creation. These are just a few which can perhaps be practiced with some common sense and a reasonable amount of patience.