Multibagger Stocks: Prasenjit Paul
Notes from Book - Multibagger Stocks: How to Multiply Wealth in the Share Market
Introduction
Introducing "Multibagger Stocks: How to Multiply Wealth in the Share Market" by Prasenjit Paul—an exceptional guidebook that unveils the secrets to unlocking wealth in the stock market. As I delved into its pages, I discovered a treasure trove of insights and strategies, illuminating the path towards identifying multibagger opportunities amidst the complexities of the market. With meticulous attention to detail, Paul navigates readers through the labyrinth of idea generation, emphasizing the significance of scanning upcoming IPOs in the BSE SME and NSE SME segments. But the true brilliance lies in his emphasis on earnings expansion—the cornerstone of multifold returns. Through Paul's expert guidance, investors are equipped with the tools to discern between revenue growth and true earnings expansion, ensuring that every investment decision is backed by sound principles and unwavering confidence. This book isn't just informative—it's transformative. Join me on a journey of wealth creation as we unravel the secrets of multibagger stocks together.
The Article is divided as follows:
Introduction
Chapter 1 : PE Ratio Expansion
Chapter 2 : Triggers for multibagger stocks
Chapter 3: Avoid Wealth Destroyers
Chapter 4: When To Sell a Stock
Chapter 5: Ideas generation and Investment flow
Important Points to remember
Chapter 1 : PE Ratio Expansion
The Price-to-Earnings (PE) ratio is a fundamental metric widely utilized by investors in the stock market. It offers valuable insights into how the market values a company relative to its earnings. Understanding this ratio is crucial for investors seeking to identify potential multibagger stocks – those with the potential to generate significant returns over time. Let's delve deeper into the significance of the PE ratio and explore the lifecycle of multibagger stocks.
Explanation of PE Ratio:
The PE ratio is a simple yet powerful formula
PE Ratio = Stock Price / Earnings Per Share (EPS)
In other words - Stock Price = Earnings Per Share (EPS) X PE Ratio
Read all about fundamental analysis here:
In essence, it reflects how much investors are willing to pay per dollar of earnings generated by the company. A high PE ratio may indicate that investors expect substantial earnings growth in the future, while a low ratio may suggest undervaluation or pessimism about future prospects.
Consider this example: If a company has a stock price of $50 and EPS of $5, its PE ratio would be 10. This implies that investors are willing to pay $10 for every dollar of earnings. Changes in the PE ratio can significantly impact stock prices, making it a critical metric for investors to monitor.
Lifecycle of a Multibagger Stock:
Initial Phase:
Market capitalization less than 500 crores.
Low liquidity and average trading volume.
Lack of institutional investors due to limited liquidity.
No institutional names that is mutual funds, FIIs or DIIs in the company's shareholders list because of low liquidity
Minimal media coverage and research attention.
Valuation metrics like PE ratio remain low compared to peers.
Advancement Phase:
Transition from microcap to small-cap.
The mid-cap and small-cap phases are the ideal stages for multibagger discovery for maximum wealth creation.
Increased liquidity and trading volume.
Institutional investors start taking positions.
Media coverage and research reports attract retail investors.
Ideal stage for multibagger discovery.
Mature Phase:
High liquidity and trading volumes.
The stocks enters into frontline index like NIFTY50 or NIFTY500
Extensive media coverage and institutional holdings.
The stock is already traded at a higher valuation. Thus despite earning growth, PR expansion is no longer visible.
Declining Phase:
Declining earnings growth leads to PE contraction.
Stock price experiences significant decline.
Occasional rallies may occur but prove to be traps.
Institutional shareholders reduce positions while retail investors increase theirs.
Understanding the PE ratio and the lifecycle of multibagger stocks is essential for investors aiming to maximize returns and minimize risks in the stock market. By recognizing the significance of the PE ratio in stock valuation and identifying the different phases of a multibagger stock's lifecycle, investors can make informed decisions to capitalize on investment opportunities and navigate market fluctuations effectively.
Chapter 2 : Triggers for multibagger stocks
Trigger 1: Margin Expansion
Margin expansion serves as a pivotal catalyst for both earnings growth and PE ratio expansion, playing a crucial role in determining a stock's trajectory. Understanding the intricacies of margin expansion and its impact on stock performance is essential for investors seeking multibagger opportunities.
Understanding Margin Metrics:
EBITDA Margin:
EBITDA margin, or operating profit margin, measures a company's earnings before interest, taxes, depreciation, and amortization as a percentage of its revenue.This margin is also referred to as the "operating profit margin"
Formula: EBITDA Margin = EBITDA / Revenue
It reflects the efficiency of a company's operations in generating profits before accounting for certain expenses.
Net Profit Margin:
Net profit margin quantifies the profitability of a company by indicating how much profit it generates as a percentage of its revenue.
Formula: Net Profit Margin = Net Profit / Revenue (Total Sales)
This metric provides insights into a company's bottom-line profitability after accounting for all expenses.
Ideal Scenario and Impact on PE Ratio:
Under ideal circumstances, both margins should run in sync - that is if the EBITDA margin keeps improving then the net profit margin should also improve, and vice-versa EBITDA stands for earnings before interest, tax, depreciation and and amortization, so if any one of these parameters shows some anomly, then it will reflect on both margins..
For instance, if a company's margin expands from 10 percent to 15 percent over several years, it signifies enhanced operational efficiency and profitability. Consequently, the PE ratio is expected to expand, driving the stock price upward. Conversely, margin contraction often correlates with a decline in the PE ratio and subsequent stock price depreciation, leading to wealth erosion for investors.
Criteria for Identifying Multibagger Stocks:
When evaluating potential multibagger stocks, it's imperative to prioritize certain criteria:
Margin Expansion Visibility:
Look for businesses demonstrating clear visibility of both EBITDA and net profit margin expansion over time.
Consistent margin improvement indicates operational strength and potential for sustained growth.
Margin Protection Capability:
Assess the business's ability to safeguard its margins across diverse economic cycles.
Companies exhibiting minimal margin volatility are better positioned to weather market fluctuations and deliver long-term value to shareholders.
Avoidance of Margin Contraction:
Identify businesses with minimal visibility of margin contraction, as such scenarios can signal underlying challenges or inefficiencies.
Avoiding investments in companies prone to margin erosion helps mitigate downside risks and preserve capital.
Drivers of Margin Expansion and Contraction:
Three primary drivers influence margin dynamics within a business:
Pricing Power:
B2B Model : B2B refers to "business to business". A B2B company provides services or products to other businesses. For example, a bottle manufacturer sells bottles to other businesses like liquor companies or pharma companies.
B2C Model : B2C refers "business to consumers". A B2C company directly sells services or products to the end customer. For example, liquor manufacturers or drug manufacturers can directly sell their end products to the customers.
B2C companies always remain in an advantageous position when it comes their ability to protect their margins because it is always easier to negotiate with retail customers than with other large businesses.
The businesses (packaging companies, active pharmaceuticals ingredients etc,) supplying to Abbott are B2B model and have no pricing power. But Abbott itself is in the B2C segment and has a lot of pricing power. Naturally, you will find a very strong and consistent margin trend.
Backward Integration:
A business that has executed backward integration has presence in the entire value chain of the industry it operates in.
A pharma company that has a presence only in the active pharmaceutical ingredient (API) segment is vulnerable to margin pressure because whenever the price of basic chemicals increases because the company has a B2B business model.The company purchases basic chemicals from some other business and then sells APIs to the formulation players.
Both its suppliers and customers are business entities, which means limited negotiation power for the company.
However, a company with presence in the entire value chain enjoys pricing power. When a pharma company has presence in the entire manufacturing chain and also sells its finished goods (medicines) to the end customers, it can then easily pass on any kind of raw materials price hike.
"A fully backward integrated business with a B2C model is the best candidate as a potential multibagger stock"
Industry Tailwinds:
Industry tailwinds are when there is a sudden demands due to some situations and the company has large stocks of the products then they can negoatiate margins.
"Industry tailwinds" refer to positive trends or favorable conditions that are influencing and benefiting a specific industry. These are external factors that can boost the overall performance and growth of companies operating within that industry. Tailwinds can arise from various sources and circumstances. Some common examples include:
Industry tailwinds encompass various external factors that positively influence and benefit specific sectors, contributing to overall growth and profitability. These tailwinds include:
1. Economic Growth: A thriving economy stimulates consumer spending, business investments, and demand for goods and services, fostering growth across industries.
2. Technological Advancements: Emerging technologies and innovations empower companies to enhance products, services, and operational efficiency, driving growth within industries.
3. Demographic Shifts: Changes in population demographics, such as population growth, aging populations, or shifts in consumer preferences, create opportunities for industries catering to evolving needs.
4. Regulatory Support: Favorable regulatory changes and government policies reduce barriers to entry, promote innovation, and support specific industries, facilitating growth and development.
5. Global Trends: Globalization, urbanization, and sustainability initiatives open up new markets and drive demand for specific products or services, positively impacting industries on a global scale.
6. Consumer Behavior: Shifts in consumer behavior, preferences, or lifestyle trends influence industry dynamics, creating tailwinds for sectors aligned with emerging trends.
7. Environmental Factors: Increasing awareness of environmental issues and sustainability drives demand for eco-friendly products and services, benefiting industries focused on sustainable practices.
8. Access to Capital: Availability of capital, low-interest rates, and favorable financing conditions support industry growth by facilitating investments, expansions, and innovation, fueling economic progress.
For investors and businesses, identifying industry tailwinds is crucial for making informed decisions and capitalizing on opportunities. Conversely, "headwinds" refer to negative trends or challenges that may hinder industry performance. Understanding both tailwinds and headwinds is essential for strategic planning and risk management within a specific industry.
Industry tailwinds can't be predicted beforehand; it should not be the sole investment rationale. In the presence of all other multibagger triggers, industry tailwinds accelerate the multibagger returns.
Margin expansion serves as a fundamental catalyst for driving earnings growth, PE ratio expansion, and ultimately, stock price appreciation. By meticulously assessing margin metrics, evaluating drivers of margin dynamics, and aligning investment decisions with multibagger criteria, investors can navigate the market landscape with confidence and capitalize on lucrative opportunities for wealth creation.
Trigger 2: Debt Management
While margin expansion remains paramount for achieving multibagger returns, managing debt effectively emerges as the second crucial determinant. The debt burden, or the extent of borrowing reflected in a company's financial records, significantly impacts profit margins and overall financial health.
External borrowings introduce a recurring obligation, necessitating monthly repayments regardless of the business's cash flows. Therefore, assessing a company's debt position is integral when scouting for multibaggers. One key metric used for this evaluation is the debt-to-equity ratio, calculated by dividing total liabilities by total shareholders' funds.
Companies with a debt-to-equity ratio of less than 0.3:
A debt-to-equity ratio below 0.3 indicates minimal debt exposure, signaling financial prudence. Companies meeting this criterion, alongside demonstrating earnings and PE expansion, present compelling potential as multibagger stocks.
Companies with a debt-to-equity ratio of 0.3 to 1:
Firms falling within the 0.3 to 1 range warrant scrutiny, as moderate debt levels can still align with multibagger prospects. However, it's crucial to monitor any trends indicating a gradual increase in overall debt.
Companies with a debt-to-equity ratio of more than 1:
A debt-to-equity ratio exceeding 1 suggests a stretched balance sheet and strained cash flows from operations. Such companies are highly vulnerable, especially during economic downturns. Historical analysis reveals a correlation between excessive debt levels, with many stocks witnessing substantial declines, often exceeding 90 percent.
Notably, it's advisable to exempt banks and financial institutions from this ratio assessment due to their unique operational dynamics.
In summary, prudent debt management is imperative for sustaining long-term growth and mitigating risks, making it a critical consideration in identifying multibagger opportunities in the market.
Trigger 3 : Capacity Expansion
Capacity expansion will always trigger revenue expansion but not always margin expansion. Thus, capacity expansion alone is not sufficient for multibagger returns from stocks.
While capacity expansion is on, if the company falls into debt trap, then its stock price will nosedive. The bigger the invetsment in the project, the bigger will be the risk. To be on the safe side, prefer to invest in companies that embark on capacity expansion with minimal capex.
Trigger 4: Capitalizing on Opportunity Size
A significant opportunity size is a prerequisite for achieving multibagger returns in the stock market. However, it's essential to recognize that opportunity size alone should not dictate investment decisions. While a vast market potential lays the groundwork for multibagger growth, the key lies in how effectively a company seizes and capitalizes on that opportunity.
In essence, while the magnitude of the opportunity sets the stage for multibagger returns, the company's strategic execution and ability to harness that opportunity ultimately determine its journey towards becoming a multibagger stock.
Trigger 5: Geographic Market Expansion
Expanding into higher-margin markets across new geographies can serve as a compelling trigger indicating the potential for a stock to become a multibagger. This strategic move enables earnings expansion without the burden of additional debt often associated with traditional expansion efforts.
Venturing into overseas markets presents a formidable challenge for Indian companies, with only a select few achieving success in this endeavor. However, for those companies that effectively penetrate international markets, the rewards can be substantial, leading to multibagger returns for investors.
Successful expansion into new geographies triggers notable margin growth, driving both earnings and PE expansion. This favorable combination sets the stage for significant stock price appreciation, making it an attractive opportunity for investors seeking multibagger returns.
Trigger 6: Leveraging the Low Base Effect
The low base effect presents a compelling opportunity for exponential earnings expansion, particularly evident in micro-cap companies with limited operational scale. Consider two hypothetical grocery retailing firms: Company A operates a single store in a metro city, generating an annual net profit of Rs 10 Crore, while Company B boasts 100 retail outlets nationwide, yielding Rs 1000 Crore in annual net profit.
Despite comparable operational efficiency, Company A emerges as the more enticing investment option due to its substantial growth potential. With just a single additional store, Company A could double its profits, illustrating the remarkable earnings expansion prospects inherent in a micro-cap setup. In contrast, Company B would face significant challenges in replicating such exponential growth, requiring a monumental expansion effort involving hundreds of new stores to achieve similar earnings expansion.
However, it's crucial to note that the low base effect's transformative potential hinges on the company's ability to capitalize on its operational efficiencies. If Company A struggles to turn a profit despite its single-store operation, expanding to multiple outlets could exacerbate losses, underscoring the importance of prudent management and strategic execution.
In summary, when comparing companies of similar operational caliber, micro-cap stocks possess inherent advantages in leveraging the low base effect to drive exponential earnings expansion and wealth creation for investors. Strategic investments in well-managed micro-cap firms offer an avenue for substantial profitability and market capitalization growth, propelled by their advantageous starting point and potential for rapid scalability.
Trigger 7: Market Sentiment and PE Expansion
While earnings expansion remains largely independent of overall market sentiment, PE expansion relies heavily on the broader market's strength. Sustained market positivity is essential for facilitating PE ratio expansion, a phenomenon that typically accompanies bull markets.
During periods of market strength, companies experiencing continuous earnings growth are more likely to witness PE ratio expansion, reflecting investor optimism and willingness to pay higher premiums for future earnings. Conversely, in bearish or stagnant market conditions, even substantial earnings growth may fail to spur PE ratio expansion, as investors exhibit caution and reluctance to bid up stock prices.
It's crucial to recognize that while earnings expansion can drive PE ratio expansion over time, the reverse is not necessarily true. If the PE ratio inflates without commensurate earnings growth, it often indicates unsustainable market exuberance, eventually leading to a correction as market realities catch up with valuation expectations.
In essence, market sentiment plays a pivotal role in determining the trajectory of PE expansion, highlighting the interplay between company fundamentals and broader market dynamics in shaping investor perceptions and stock valuations.
Improvement in margin is a must for PE expansion and without PE expansion the stock price suffers.
Irrespective of sales growth, if the net profit margin declines then the stock price will disappoint.
Chapter - 3: Avoid Wealth Destroyers
In the pursuit of multibagger returns, certain key insights emerge as guiding principles for investors:
1. Revenue Growth:
Contrary to common belief, total sales or revenue growth ranks as the least influential parameter in the multibagger journey. Many instances exist where substantial revenue growth fails to translate into positive stock performance.
2. Margin Expansion:
Margin expansion stands out as the foremost trigger for achieving multibagger returns. Beyond driving earnings growth, expanded margins facilitate PE ratio expansion, laying the foundation for substantial stock appreciation.
3. Debt Management:
Debt remains the most perilous factor in investing, with incremental debt capable of fundamentally altering a company's business prospects. Prudent debt management is paramount to safeguarding long-term shareholder value.
4. Management Commentary vs. Reality:
Despite optimistic management commentary regarding a company's bright prospects, investors should exercise caution when confronted with increasing debt levels and elongating cash conversion cycles. Actions speak louder than words, and deteriorating financial metrics often belie rosy projections.
Checklist for Spotting Wealth Destroyers
1. Complex Business Models:
While hunting for multibagger in the small cap and micro-cap space, to be on the safe side, it is better to avoid difficult to understand businesses.
2. Margin Contraction:
Avoid companies demonstrating historically volatile margin trends when hunting for multibaggers. Consistent margin contraction poses a significant risk to investment returns.
3. Promoter Holding Below 50%:
Promoter holding below 50% signifies diminished confidence in the business. However, it could also result from excessive equity dilution.
Exercise caution and avoid small and micro-cap stocks with promoter shareholding below 50%.
4. Declining Promoter Stake:
Promoters can reduce their stake in their companies for various reasons. This can have different implications for different stocks.
Common sense suggests that, if a business owner senses a bright future with strong growth for his company, he should never reduce his ownership of it.
Avoid companies where promoters are reducing their stake.
5. Pledged Shareholding:
Promoters often pledge shares as collateral for fundraising, indicating financial strain. Pledged shares, especially in small and micro-cap stocks, warrant scrutiny.
For small and micro-cap stocks pledged shares can be a red signal, whatever the proportions pledged.
Avoid companies with pledged shares, irrespective of the proportion.
6. Social Media Noise:
Excessive chatter on social media platforms about a stock warrants investigation. Verify trading volumes and promoter involvement before making investment decisions.
By adhering to this checklist, investors can mitigate risks associated with wealth destroyers and enhance their chances of identifying lucrative investment opportunities in the small and micro-cap segments.
Chapter - 4: When To Sell a Stock
Avoid Selling Based on Price Movements:
Never make selling decisions solely based on a stock's price decline by a certain percentage. Price fluctuations are a natural part of the market and should not dictate investment actions.
Remember, a stock's price is merely a numerical representation of market sentiment and does not necessarily reflect the underlying value of the company.
Case Study 1: Chemcrux
Earnings Expansion in Bear Market:
During bear markets, identifying stocks exhibiting consistent earnings expansion amidst overall market weakness is crucial. Consider the scenario of the 2018-19 bear phase in the small-cap index, where investor portfolios experienced varying performances:
1. Stock 1: 10% gain
2. Stock 2: 5% gain
3. Stock 3: 30% decline
4. Stock 4: 50% decline
5. Stock 5: 60% decline
Which stocks should be prioritised for selling?
Most investors might consider selling the first and second stocks, assuming nominal profits. However, this could be a costly mistake. In a bear market, a stock's apparent strength can stem from earnings expansion, even as the overall market weakens. While the PE ratio may contract or consolidate during this period, it is likely to rebound once a bull market resumes.
Therefore, stocks demonstrating moderate gains during a bear market due to earnings expansion hold potential for multibagger returns in subsequent bull markets, as both earnings and PE expansion come into play. The seemingly weaker performing stocks may, in fact, be the golden eggs of the portfolio, and selling them prematurely would squander their future potential.
In summary, the adage holds true: "Never sell a stock showing earnings expansion amid overall market weakness." Identifying such stocks and holding onto them during bear phases can yield substantial returns when market conditions turn favourable.
When to Sell a Multibagger Stock
Excessive PE Expansion:
The most crucial trigger for selling a multibagger stock is excessive PE expansion. While PE expansion is instrumental in driving multibagger returns, it's important to recognise its limits. When the PE ratio reaches exorbitant levels, it typically initiates a phase of contraction or consolidation. While this pause may cause temporary concerns, it's usually manageable as long as earnings growth remains robust.
However, if earnings growth begins to slow down, it can accelerate the stock's downward trajectory. Therefore, during periods of PE expansion, it's essential to closely monitor not only the PE ratio of similar stocks but also the potential for future earnings growth. Sustainable high PEs depend on clear visibility of continued earnings growth. Any indication of a potential slowdown in growth can exert pressure on the PE ratio.
When considering selling a multibagger stock, refer back to your initial investment thesis. Keep a record of the triggers for earnings and PE expansion identified during your investment analysis. If these triggers are no longer valid or if the investment reasons have changed, it may be time to exit the stock. By maintaining clarity about your investment rationale, the decision to sell becomes more straightforward and less emotional.
Chapter 5: Idea Generation and Investment Flow
Idea Generation
One of the most direct paths to uncovering multibagger opportunities is by scanning upcoming Initial Public Offerings (IPOs) in the BSE SME and NSE SME segments. Annually, a substantial number of SME companies, ranging from 40 to 70, are listed.
Additionally, it's crucial to monitor equity dilution events such as rights issues, Follow-on Public Offers (FPOs), etc. These initiatives can increase the total number of shares, consequently reducing Earnings Per Share (EPS).
It's important to note that while revenue growth is noteworthy, multifold returns are typically generated through earnings expansion. Without robust earnings growth, even significant revenue increases may not translate into substantial returns for investors. Therefore, focusing on companies demonstrating consistent earnings expansion is paramount in the pursuit of multibagger opportunities.
Quick Checklist for rejection of a stock
While scanning for the company profile ask these questions:
1. What' special about the company?
2. Is it doing something different, something unique, that no one else is doing?
3. There are no other similar companies listed on the Indian stock market. Why is that?
4. Does the company have a moat or competitive advantage?
Important Points to remember
A close look at lalchandani lab's balance sheet suggested the problem lay in their cash conversion cycle. Let's understand this metric first. The cash conversion cycle is the number of days that a company requires to convert its resources into cash through sales. Remember, "Sales" and "cash" are two different things. It might happen that a business records sales but receives payment for them after a certain number of days. A higher cash conversion cycle means the fund are getting blocked or tied up in the business, which means the business is struggling to collect cash.
1. Never ever average stocks on their downward journey
2. Never buy any stocks at its 52 week low
Price is just a number:
The stock price in absolute terms carries no significance in the context of multibagger returns. Just because a stock price doubles in the last few months doesn't necessarily mean that it can't repeat it in the coming months. Sometimes, a stock at a higher price can be effectively cheaper than when it was in a lower range. For example, beta drugs was traded at the Rs 650-670 level in January 2022, at that time, the PE ratio was hovering around 50. After a few months, in may 2022, while the stock price was at the Rs 800-850 level, the PE ratio moderated to the 30-35 level due to the earning expansion.
For multibagger, you need to focus on micro-cap and small-cap stocks that are still in the early stage of the business life cycle with huge growth potential ahead. Trading volume is minimal in micro-cap and small-cap stocks. In fact, many micro-cap stocks are not even traded daily. Technical analysis stands on the trading volume and price movemnts. Thus in the absence of sufficient trading volume, technical analysis becomes redundant.
To avoid major capital loss while hunting for multibagger in the small-cap and micro-cap space, if any of the following parameters holds true, avoid the stock:
1. Cyclical business
2. Business with no pricing power; can't pass on input price hike to the end customer
3. Business with no competitive advantage or moat
4. Business with absolutely zero entry barriers. Anyone with nominal capital can start the same business.
5. Difficult to understand business
6. Historical net profit margin shows a highly volatile trend
7. Company showing inflated profits just before IPO
8. Debt-to-equity ratio is more than 1
9. Overall debt increasing significantly every year over the last three years
10. ROE and ROCE are both less than 12 percent
11. Both ROE and ROCE are decreasing every for the last three years
12. Promoter holding less than 50 percent
13. Promoter group selling their stakes
14. Promoters have pledged part of their shareholding
15. Cash flow from operations (CFO) is negative every year for the last three decades
16. Too much social media hype and many market participants suggesting investment in that particular stock
17. You are getting free tips on the stock from unknown sources via SMA, email or telegram.