The term was first coined and incorporated by the investor Peter Lynch. Multibagger stock can be defined as the stock that multiplies many times. Thus potential multibagger stocks are quite sought after in the world of investment. They are usually high growth stocks. They may not provide exponential initially but are capable of generating returns in triple digits over a long tenure.
Though these are much popular options to invest, identifying and picking a potential multibagger isn’t that easy. Thus while aiming to understand how we can pick multibagger stock, we need to first discuss its characteristics and the factors that help these particular stocks grow into multibagger.
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Well, the answer is not that simple. However, with some simple rules and the investors understanding of stock market, one can pick up a multibagger that holds the potential to double the investor’s money in the long run.
Usually, multibagger stocks are highly risky. If we study the 10 best multibagger stocks we will find that these stocks belong to the small-cap or mid-cap space. Large-cap stocks cannot be multibagger as they have already left their best growth years behind. Whereas the small-cap or mid-cap funds are the stocks of high growth companies and thus the stocks carry high risk and are volatile. So you need to exercise caution while choosing multibagger stocks.
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Since the multibagger stocks amplify you investment through profit-driven growth, so the first criteria is to look for stocks where you can sense you can get high returns in the next 2-3 years.
You must also track the changes in the profitability ratios like ROE, ROCE and free cash flows of the company. This happens when the company’s margin or capital efficiency is improving. Checking other factors like corporate governance may help you to understand and avoid sudden price moves.
However, there are certain misconceptions prevailing among investors about picking multibagger stocks. A section of investors believes that the stocks that trade at 52-weeks low are potential multibaggers and can provide exponential returns when the market reverses the trend. However, this might not seem logical if you are looking for stocks that can perform consistently. When the market crashes, the long-term investors should pick the right stock that holds the potential to give steady returns. Apart from this, companies that also exhibit signs of a major turnaround also qualify as potential multibagger stocks.
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Follow the six basic rules while picking the right stocks having the potential to turn into multibaggers:
Quality Management: The way in which the company is managed will give you the idea of the company’s performance. If the company maintains high standards of corporate governance, if they timely disclose information to the shareholders, if their interest aligns with that of the shareholders then the company is can be considered fit for investment.
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In contrast, a company that is not honest will never want to share its profits with shareholders and may use the opportunity for personal enrichment.
Return on equity (ROE) is a measure of the company’s profitability where the net income of the company is compared to the shareholder’s equity. Similarly, ROCE measures the overall returns for all stockholders and is a relative measure of the overall efficiency of the company. Multibaggger stocks usually have high ROE and ROCE relative to entities. Typically these companies generate positive free cash flows consistently. It also means lower debt in the company’s books thus making it a potential multibagger.
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Most multibagger companies should be lean and require minimal operating capital while capable of generating higher returns with free cash flows. Such businesses can not only fund their growth but are also capable of rewarding shareholders. If the business requires huge capital to operate then it may not give exponential returns even in the long-run.
It is important to consider other parameters like the financial ratios of the company. The financial ratio will give you an idea of how the brand performs in the future. In some instances, the shares of the company may look attractive for the next 2 years but its value may decrease when held for 5 to 7 years. Thus financial ratios can help you to determine the potential valuation of the company.
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Though the above-mentioned points cannot be considered a guaranteed way to find multibagger stocks it will allow investors to choose and invest in the right set of stocks. A thorough research based on the above-mentioned points you can avoid stocks that may degrade in value in the coming years.
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