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Q&A: Finding 100-Baggers

I get a number of emails about 100-baggers and I have noticed patterns, or recurring themes, to these questions. I’ll answer several of these common questions below, including the most asked question, “Which stock do you think will be a 100-bagger?”


Where do you get ideas?


Always a top question. People like to ask if I use screens. Sometimes, I do. I have a friend who runs a fund and creates screens (which he shares with me) that turn up interesting names to research. So, that can work.


I get a lot of ideas from just talking to people -- other investors, businesspeople, analysts, etc. I would also recommend “fintwit” - the financial community on Twitter. Lots of people talk about their favorite “compounders.”


At great risk of offending people I’ll forget to mention, here are some people on Twitter who talk about ideas and whose accounts are open to the public and worth following for “compounder” ideas:


@SVNCapital, @_inpractise, @the10thman1, @YHamiltonblog, @kylerhasson, @maxwellhouse99, @BarrySchwartzBW, @CompoundingCap1, @ohcapideas, @JBierne, @Post_Market, @soonervaluecap, @puppyeh1, @BlueToothDDS, @borrowed_ideas, @LibrarianCap, @jj_shipley, @compound100x, @andrewhollingw, @marketplunger1, @JerryCap, @GWInvestors, @PythiaR


Check them out and look at who else I am following on Twitter for more ideas...


Portfolio structure?


People like to ask me how they should structure their portfolios. There seems to be two schools of thought. The first is to concentrate -- come up with roughly a dozen favorite businesses to hold for the long haul. The second is what I’ll call the venture capital approach -- you create a portfolio of 30-50 names of 2-3% positions and hope a few of them hit.


I like the former approach. There aren’t that many ideas that meet 100-bagger style hurdles that I can get some conviction on owning. Besides, I enjoy learning about and following my portfolio companies at some depth. I can’t realistically do that if I own 30 stocks.


However, portfolio structure is more a personal choice. I don’t think there is a “right” answer here. Do what you are comfortable with. The more important thing is to create a portfolio you can hold onto, through thick and thin, to reap the glorious rewards of long-term, tax-deferred compounding.


What about the valuation of X stock?


I get a lot of questions about valuation. I think if I had to re-write the book, or if I ever get around to a second edition, I might emphasize what I am about to say more than I did.


No doubt, it’s wonderful to find a situation where you have a low multiple and lots of growth so you can get the lift from the “twin engines” (a rising valuation and growth). But those opportunities are often quite rare.


I would put the business first, valuation second. If you have a business that checks every box except valuation, I would not let that discourage you from owning it -- unless the valuation was really out there. You can always start small and build up the position over time.


Another seldom mentioned side-effect of focusing too much on valuation: It’s going to make it that much harder for you to hold on. If you want to nab a 100-bagger, or even a 10-bagger, you’re going to have to learn to hold on to overvalued stocks. It happens, in the life of a 100-bagger, that the stock will trade well above what you think it’s worth. Suck it up and hold on. But if valuation is a big part of your thesis, that’s going to make it tough to do -- and it’s already tough.


Footnote to the above: On valuation, you should try to ditch the following two ideas:


1. That the price-earnings ratio or price-book ratio or EV-to-EBITDA ratio (and their many siblings and cousins) are useful valuation metrics on their own. Let’s focus on price-earnings ratio, because what I’m going to say will apply to all of the others. P/E is often used as a valuation measure -- i.e., lower P/E is “cheaper” than a higher P/E. But P/E misses so many things, it’s useless on its own. Here is what P/E doesn’t tell you:


  • How much capital is required to produce a dollar in earnings? A company that needs to invest $100 to create a $1 annual earnings stream is not as valuable as a business that needs to invest only $1 to create $1 of ongoing annual earnings.

  • How much of those earnings convert to free cash flow? A company earns $1 in earnings and converts that into $1 of free cash flow is more valuable than a company that needs to reinvest half of its earnings just to stay in place.

  • What’s the return on the capital invested in the business? Higher is better, taking into account, too, the future.

  • What does the reinvestment opportunity look like? Does the business have the ability to revinvest its profits and what do the incremental returns on that capital look like?

  • What does competition look like? Or how sustainable are those earnings and cash flows?


That’s a start. There is no way to make a valuation judgment on any company without taking into account, at a minimum, the above factors. Higher returns on capital with ample reinvestment opportunities that can go for years and years, for example, deserve higher valuations… way higher valuations.


People forget this and so you’ll see -- as I have seen on Twitter --- somebody say XYZ Oil Royalty stock is a better bet than TPL (which I own) because it’s “cheaper” on a price-to-whatever metric. Of course, the returns on capital for TPL are higher than XYZ by factor of 5x to 10x…


As an aside, this means you can drop all those charts showing how Japan’s stock market (or whatever stock market) is “cheaper” than the “US stock market” (whatever that means) using an array of valuations such as P/E, Shiller P/E, P/B, etc. -- without also taking into account some basic return measures (ROE, ROA, ROIC, etc.). You’ll find the more valued markets generate better returns on capital, and therefore should be valued higher.


2. That you shouldn’t buy stocks at their 52-week highs but wait for dips. I used to pass on stocks sitting at their highs. I would try to wait for dips. I preferred to buy stocks at big discounts to their 52-week highs, or stocks near their lows. Silly belief. And one that has cost me money over the years. (When I finally bought Constellation Software after years of watching it like a dummy, I paid something close to the 52-week high. My return on that purchase is quite good now.)


One thing my study of 100-baggers taught me -- and this is intuitive anyway, if you think about it -- is that the best performing stocks spend most of their time near 52-week highs. It makes sense. A stock that is a great performer over a long period of time -- the exact kind of stock you want to own -- is a stock that is putting in new 52-week highs fairly regularly: a beautiful long-term chart that is up and to the right. How else could it be a great performer?


Conversely, what stocks tend to spend most of their time near lows? The ones you don’t want to own. And yet I used to arrogantly believe that I could pick which one of these bottom dwellers would be winners. I’d find a stock that sucked for years, but think that after I bought it, magically, the stock would be a winner. Hard game to play.


Yes, there are exceptions -- the other thing my study showed me was how all these big winners suffered heart-stopping drawdowns. So you’ll get chances, but when these stocks are suffering big drawdowns they are tough to buy psychologically. Often the whole market is going through some convulsion. Or a company specific concern can drop a stock 50% or more. But let’s not pretend we can just walk over and calmly pick up some shares. Don’t underestimate The Fear. Buying shares when things are imploding takes courage -- and you might not have it.


And finally, the most asked question: What stock do I think could be a 100-bagger?


Well, I wouldn’t want to saddle any small-cap stock with such expectations. Plus, there is really no upside in me giving a name. Disappointing, right? You wanted a ticker.


I could give a bit of a cop out answer by naming a few larger cap stocks that I think could get there. I bet Evolution Gaming, based in Sweden, will get there. Constellation Software is almost there -- maybe it’s already there, including dividends and its spinoff, Topicus (another stock that seems to have all the ingredients to make a run over the next two decades). I own all these stocks, by the way. A couple of stocks I own are already in the club, such as Copart and Heico, but I believe are still great businesses with bright futures and well worth holding.


Anyway, I’m not going to pitch my whole portfolio to you. (I only own 11 names, and I’ve mentioned six in this post). I’m just trying not to dodge the question entirely, but still give something of a useful answer.


The important thing is to create a portfolio of businesses that seem to have the essential ingredients to make a long run -- high returns on capital and opportunities to reinvest are two critical ingredients. And the business is going to have to be able to do this for a long time -- so you’ll want strong competitive positions and big markets to grow into. But all of this is in the book. Or I should say books, because Thomas Phelps wrote a fine book about 100-baggers, too.


Thanks for reading!


***

April 6, 2021

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