We have all heard stories or read methods for picking multi-bagger stocks. Today, we share with you a short and simple two-step process for building a 15-20 stocks multi-bagger portfolio.
Why portfolio? Well, when you invest in just one or two stocks, some or the other thing can always go wrong. However, when you apply the rules and processes and build a robust portfolio of 15 to 20 stocks, even if five go wrong, your portfolio will still do incredibly well.
So, here’s the two-step process for building a multi-bagger portfolio of 15-20 stocks:
1) Shortlist companies that have a track record of consistently managing year on year growth in sales for the last 7-10 years without equity dilution.
Why year-on-year growth in sales? This aspect is important. We are not talking about 15% CAGR in sales wherein the sales may have dropped 25-50% in the interim. Yes, there can be a few odd years with a small drop in sales, but here we are looking for growth in sales across the years. This is because managing sales growth year on year in any business is extremely tough.
Why no equity dilution? No dilution in equity or very small (10-20% over 7-10 years) is fine. However, we have to avoid companies that keep on diluting equity almost every 2nd or 3rd year. This is because it’s difficult to trust the numbers of companies with incessant equity dilution.
2) Once you have shortlisted the companies, add them to your portfolio during periods of contraction in margins and profits. For example, If your analysis suggests that mean operating margins for the company are around 15%, then don’t buy such stocks when say the margins have improved to 20-25%. Try and buy them when the margins are around 15% or even better say 12%.
Why not when margins are higher than mean margins? For the simple reason that the margins and the profitability may not sustain in most of the cases and the stock could come crashing down with an interim dip in profitability.
Why buy them at depressed margins? First, because one can get stocks at depressed valuations with the dip in profits. Second, because margins may revert to mean or go through an up-cycle in most of the cases and with expanded sales, the increase in profits will be substantially higher
Basically, the whole idea is to buy good companies during their periods of distress so that when the profits recover, you get the multiplier effect in the form of expansion in sales, expansion in profit margins and lastly the expansion in PE multiples.
As mentioned above, even if 10 stocks out of 15-20 do well, your portfolio will become multi-bagger in the years to come.
This article was first published here.
Ekansh Mittal is founder, Katalyst Wealth.