How to identify Multi-Bagger stocks?
In this article, we will learn how to identify Multi-Bagger stocks, using both fundamental analysis and technical analysis.
As a rule of thumb:
- Fundamental Analysis tells us which stock to buy.
- Technical Analysis tells us when to buy and when to sell (especially when to sell).
So, both are useful. But first things first!
- What are Multi-Bagger stocks?
- How to identify Multi-Bagger stocks?
What are Multi-Bagger stocks?
These are the stocks that grow very fast. So, unlike most other shares that may double or triple your invested amount over a period of time, these multi-bagger stocks give multiplication effects and may increase your investment 10, 20 times, or even more.
But how to identify them before others?
How to identify Multi-Bagger stocks?
For this purpose, we can use both fundamental and technical analysis.
Fundamental Analysis to identify Multi-Bagger stocks
Large cap companies, and even medium cap companies, cannot give you such huge returns. Only small cap companies can provide such multiplication effects on your investment. However, where there is huge return, there is huge risk too. Just keep that at the back of your mind.
So, we will do our fundamental analysis on small cap companies. Most of the basics will remain the same as noted in our article on fundamental analysis. However, we will check some more facets of these companies.
- Make sure the promoters/founders and management of the company have a healthy chunk of shares, and that they are not selling them. If they are buying more shares, it’s even better. Good sign!
- Make sure that some large investment institution (e.g. some FII, mutual fund manager, insurance fund, etc.) has not already invested in it. As soon as such big investors invest in such a small share, its price will sky-rocket. And you would already have missed the bus! Be proactive, and recognize such shares before the big bulls of the market. A difficult task indeed for a retail investor, but hey!, who said making money was easy. If a stock is in news, it’s probably already too late for you.
- Business model of a company is important. Make sure that the company has a specific niche. That is, it must be the best (or very good) in something. In fact, many stocks that became multibaggar had a monopoly over their market (i.e. no competitor), or were in duopoly (only one competitor).
- It would be preferable if the company has a recurring revenue model, i.e. a customer must buy its services/products again and again. For example, Adobe cloud services have a yearly/monthly subscription model. So, a customer has to pay again and again to keep using its products.
- The work done by the company should preferably be difficult to replicate. For example, technologies developed by Google, or Apple, or it has some patents/licence of the products it sells. Or, maybe not many people prefer to do what that company does. To summarize, the entry hindrance in that business should be high. Otherwise, in a few years many more similar companies may come up that may defeat the company you invested-in in its own game.
- If the company is involved in some evolving technology, then it may give you windfall returns, given that technology gains traction in future. But we cannot be sure if that given company will be the leader in that technology in times to come, even if that technology works. Can you predict the leading company in electric vehicles, metaverse, or blockchain technology 10-15 years down the line? So, it’s a high risk - high reward game. That’s why some investors rather just focus on established technologies only.
Generally, companies compromise either on their margins (i.e. profit per item) or the volume (i.e. the number of items they produce). For example, BMW has huge margins but cannot sell many cars. While, Maruti sells a lot of cars, but has minimal margins (A company may have huge return on investment - ROI, or return on equity - ROE, even though it has small margins. In fact, generally the companies having huge ROE have low margins and huge sales). If you can find a company that does not need to compromise on either of these two criteria (e.g. Eicher, Apple, etc.), and you invest at the right time, you may earn huge profits. But such companies are rare. So, keep in mind that as per some experts, return on investment (ROE) is more important than margins.
Smart investors (like Warren Buffet) often work opposite to what the market is doing, i.e. they flow contrary to market sentiments. They buy when others are selling, and vice-versa. But this may prove to be very risky too. Do not do this till you have wide and in-depth knowledge of share market, and the company you are investing in. Sometimes, market sentiments may prove right!
If a share has become too popular – it’s in news, people are talking about it, you should probably stay away from it. It’s already too late! Sometimes, these news articles and debates on news channels may be paid too, i.e. promoted by the promoters/management of the company itself.
Keep track of the big investments in stock market. Big bulls of the market invest their money only after extensive research, and you may follow them. It’s a safe strategy. But even then, do your own research too – never be a blind follower!
Have a look at India Vix index too. It is a volatility index based on the NIFTY Index Option prices. If investors are fearful, they will withdraw money from stock market, and so the stock prices will fall, and India Vix index will rise. So, high value of India Vix index shows high fear and low greed. While, low value of India Vix shows low fear and high greed. You should invest when everyone else is fearful.
We hope, you got the idea. Here, you have to think like an angel investor, who is investing in a new start-up. Your fundamental analysis needs to be much more detailed/comprehensive and in-depth.
However, keep in mind that long-term, big breakouts that sustain themselves over many years only come due to some fundamental catalyst. For example, share of Reliance was not moving up for many years even though it was a big company. Its share started moving up only after it announced the launch of Jio. So, follow the news and keep an eye on such developments that can act as a catalyst in the growth of a particular company (or even a whole sector).
In general, if you see that the stock price of an otherwise good company is not increasing for many years, then there’s a big chance that once it gives a breakout, it will rise very rapidly and will rise a lot. Like a spring that has been compressed for many years!
Technical Analysis to identify Multi-Bagger stocks
Yes, technical analysis is useful even while investing long-term in share market (and not just in short-term intra-day trading). Let’s see how to do so.
For general analysis, an investor (or even positional trader) should look at monthly charts. Or maybe weekly charts too.
You should exit a stock once it starts making lower tops and lower bottoms on long-term charts (monthly or weekly). To find the exact right moment for an exit (or even entry), you should definitely refer weekly charts.
Long-term Moving Averages
For investment, we should definitely have a look at long-term Moving Averages. It will give you a fair idea whether a particular stock is overperforming or underperforming at present.
Say, its average for the last 52 weeks is lower than for the last 26 weeks, then it means that the stock is performing better now. It is trading above its 52 weeks moving average.
We should invest in a stock that is doing better than before, i.e. a stock that has bright future prospects.
So, we have recognized the right stock. But when exactly should we buy that stock? For that we should wait for a dip in the price and then a breakout. Once the stock price breaks its previous resistance, buy it. Some experts suggest that we should buy the stock once its current price crosses its last 52 weeks moving average.
There are basically two types of traders:
Value Traders: Traders who like to buy when a stock price dips. They may end up buying the stock at a bit lower price, but they may have to wait a lot of time for the breakout. So, their capital gets stuck till then.
Momentum Traders: Traders who buy only once they see a breakout. Though waiting for breakout means that they may have to pay a few bucks extra to buy the same stock, but the plus side is that they get to see profits sooner. So, their capital does not get stuck for long.
Both strategies are ok, with their own pros and cons. You have to decide which one suits you more, and matches more with your personality. If you are waiting for a breakout then you will have to be a more active trader and have to monitor the stock on a regular basis, or else you will miss the breakout. If you are more laid back, you may buy the stock at its dip and wait patiently for the price to rise eventually.
Some traders have a very bad habit of averaging out too much. That is, when they see that the price of a stock is falling, they keep on buying more. They do so because they think that they are getting a good stock at low price and its price will rise again. But it’s a risky strategy. Betting on a losing horse may prove catastrophic in the long term. Do not do so until and unless you are definitely certain that the stock has solid inherent value and will definitely rise again.
Company shares, shares of a particular sector, and even the whole market too move in cycles. It rises, move sideways, falls, move sideways, rises again, etc.
If you can identify the stage when the price of a stock/sector/market are at its low, you will gain a lot once the bullish cycle hits.
Apart from fundamental and technical analysis, you can just apply your common sense to invest in a share. It’s called common sense investing.
Just look at the world around you and see what things you use on a regular basis, the companies you rely on blindly, and buy their products again and again. You will get your answer on which company to invest in.
If you can recognize such a company while it’s small and still growing, you will sure hit a jackpot. Its stock may prove to be a multi-baggar stock.