What if a stock provides returns with more than 100 percent returns with a two -digit investment? Enticing isn’t it. Recently, the stocks of Mphasis Limited – an IT service management company went staggeringly high and is said to have delivered more than double of investor’s money so far in 2021. The stock’s value ballooned from Rs 1531 to become Rs 3301 and has gained 116 percent in 2021 and rose by 138 percent from the past year.
Such a leap in stock prices of Mphasis can be attributed to its acquisition of US-based design consultancy Blink Interactive Inc for a total consideration of $94 million, including earnouts.
What are these stocks that are delivering such high returns? These stocks are known as multibagger stocks. As the name suggests, the word ‘bagger’ to the stock name showcases the return multiplier. For instance, if it is a 5-bagger stock, the stock gives 5 times returns or it will be called a 100-bagger stock if its returns are 100 times.
Let us deep dive further to understand how to identify such multibagger stocks of a company.
What are multibagger stocks?
A multibagger is a stock that has the potential to generate explosive returns to its investor in a short time. The returns delivered are several times higher than the initial amount. For instance, let us take the recent example of the stock price of a renowned textile company Welspun India whose price surged from Rs 68 to Rs 156 in a single day and has gained 129 percent since the beginning of 2021 and rose to 160.5 percent from 2020.
Businesses whose stock prices have skyrocketed in a short time are known to have unique characteristics such as a strong financial performance, reliable and capable management, efficient capital allocation strategy, and robust free cash flows, etc.
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Recently, in 2021 the stocks of Mphasis Limited - an IT service management company went staggeringly high and is said to have delivered more than double of investor’s money.
How to identify multibagger stocks?
The stock market can never assure returns while we invest in a stock, but certain signs can help an investor identify multibagger stocks.
Look at the P/E ratio and EPS (earnings per share)
The rule is simple, an investor can milk profits only if the company makes profits. We should look at the earnings of a company to find an upward trajectory. Typically, the company of a multibagger stock will have a high revenue growth model, profitability model, and capital allocation model.
Investors can calculate EPS (earnings per share) of trailing 12 months to check against each share how much a company has earned. In the case of a multibagger stock, the EPS should be on a climbing mode. Another metric to find if the company is making profits is through the P/E ratio. The probability of a stock becoming multibagger is high if its P/E ratio is high as compared to its stock price.
Apart from these two metrics, one should also look at the debt to ensure that it is not more than the EPS value.
Check EBITDA and revenue
To determine multibagger stocks, investors must look into the quarterly performance of the company’s revenue, EBITDA, and net profit. Parameters – revenue and EBITDA – reflect the company’s operating profitability and cash flow. If the EBITDA numbers are high, it reflects the company’s operating expenses to be low against the profits earned eventually meaning the cash flow to be high. Such signs make the stocks multibagger.
Moreover, the stocks of the companies should be able to produce sustained margin over time that does not vary with every quarter or year.
Strong management
A strong management team is key to a business’s growth. Aspects like governance practices, board independence, diversion of funds to other businesses or for personal interest, pledging of shares, discipline with obligations, capital expenditure and financial matters, etc. should be researched by the investor. Good management practices have an impact on a company’s operations eventually driving its profits.
Source of earnings
With revenue numbers, one must check the sources from where the company is making money. See, if the operations of the company are easily scalable? The primary revenue should be able to grow at the macro level to become a stock giving explosive returns.
Benefits of investing in multibagger stocks
Multibagger stocks yield tremendous returns that increase investor’s wealth. Also, purchasing multibagger stocks is not risky since such companies can withstand failures and can perform well.
Are risks involved in multibagger stocks?
Investing in multibagger shares can throw investors into the problem as trading at high prices might be a possibility of creating an asset bubble. An asset bubble is formed when the prices of stocks or securities surges at a rapid pace without any strong fundamentals such as EPS, P/E ratio, etc. to justify the rise. When investors pin their high hopes on the stocks to perform but if the company’s products fail to perform in the market, this is where the bubble bursts resulting in massive losses.
Thus, investors need to carefully analyse the financial statements of a company and the prevailing market situation in stock markets before investing in multibagger stocks.
