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Reflections on 100 Baggers

My book 100 Baggers has been translated in Korean and Mandarin and most recently published in a Malaysian edition. As part of these releases, I’ve done a number of interviews with people in those markets. A lot of the same kinds of questions come up. I thought I’d share a few, and my answers, in today’s post.


“Do you think the next 100 baggers companies are mostly in the tech sector? What other sectors should they look into?”


The sector question is one of the most popular. It almost always comes up. My answer is that sector or industry does not seem important, or at least, has not been.


I love to point out that both Google and Domino’s Pizza went public the same year - 2004. The performance to date? Google up 2,744% and Domino’s up 2,828%. Domino’s wins by a pizza slice...


It like the example because it's surprising to most people. Pizza seems like such an ordinary business. And yet. Just a casual perusal of the list of past 100 baggers shows a diverse mix of industries: Campbell Soup, Deere & Co., Halliburton, Boeing, Duke Energy, Cigna, Chrysler… Even if you just look at the stocks that got to 100x the fastest -- all inside of ten years -- you still get a mix of industries with no one industry dominating.


So, I would say that the recipe for 100 baggers is agnostic on industry. That the part of the 100 bagger recipe reads “add industry to taste.” You may focus on certain industries as a practical matter -- i.e., you can only cover so much ground. Or you might focus just because you like a certain industry and you’re intrinsically interested in learning about it and following it. Don’t discount enthusiasm as a driver of returns. It helps to enjoy what you’re doing. Investing is hard enough; it’s harder when you’re bored. Follow your curiosity and interests.


One more point on industry: It’s just a label. Don’t get so caught up on what labels other people put on certain businesses. What is “tech” anyway? It’s such a broad blurry label.


Last week, The Wall Street Journal ran a story about how tech’s influence on the S&P was at an historic high. Here was the lead paragraph:


“Technology companies are set to end the year with their greatest share of the stock market ever, topping a dot-com era peak in the latest illustration of their growing influence on global consumers.”


Of course, I wondered about that label “technology companies.” And the very next paragraph called into question its usefulness - unintentionally, I think:


“Companies that do everything from manufacturing phones to operating social-media platforms now account for nearly 40% of the S&P 500…”


Well, how useful is a label that includes those two businesses as being similar? I would say not very.


You might as well create the “M sector” and include McDonald’s and Microsoft and any company that starts with the letter “M.” Then you can write stories like “The M sector made up X% of the S&P 500 at quarter end, compared to X% at the start of the year.” You can have analysts opine about the “M sector” and talking heads on TV argue about how much the “M sector” should be in your personal portfolio. You could produce nice slide decks with charts and P/E ratios and price targets… You could even create an ETF, do back-testing...


Maybe I overstate my case. But if you’re looking for 100 baggers, I would not put your focus on industries. The key ingredient seems to be something else.


“What is the key ingredient to a 100 bagger?”


Ah well, always the big question. In my view, the key ingredient is return on capital. That’s the gin. And the ability to reinvest is the vermouth.


Now, return on capital is a vague term. And this is an area I am still refining. But broadly considered, the key ratios to consider include “return on invested capital,” or “return on capital employed” or “return on assets” or “return on equity” or…


You get the idea. You can google any of these terms and get formulas. Which one you use will partly depend on the business you’re looking at and what makes sense. But the basic question you’re trying to answer is how good of a business is this? In plain english, we want a really good business and a really good business is one that generates a high return on the capital invested in it.


And since the road to 100 baggerdom is a long and twisty road with lots of hills and valleys, you can’t just do it one year. You want a business that can crank out those high returns year after year. That means you have to think about a lot of other things as well, like competition and growth potential and the ability to withstand economic cycles, etc.


So, that’s return on capital. But what about the ability to reinvest?


The ability to reinvest means that -- again, ideally -- you want a business that can take all of its profits and reinvest them back in the business and earn that high return on capital again…. And again. And again. Etc.


In the real world, few companies can do this. There are taxes. There are capital expenditures you have to make just to keep the lights on. Few businesses can reinvest everything. And there are great businesses that require so little capital to keep growing that they generate tremendous surpluses of cash.


So, companies pay dividends… or do acquisitions… or just sit on cash… or blow the money building palatial headquarters. It happens. Therefore, just as return on capital leads you think about different questions, so too with reinvestment. You’ll have to think about what a business does with the cash it generates. Capital allocation becomes important. You have to think about management.


But at the end of the day, the two most important things are again: a high return on capital + the ability to reinvest. (Stir in a coffee can and bury it. Because you also need time, the hidden key “third ingredient” of a 100 bagger. Think a couple of decades.)


If I had to re-write the book today, I’d really spend more time emphasizing these two points. In my mind, when I think of a “high quality business” I’m really thinking of a business that scores pretty well on these two points.


“What about valuation?”


People also like to ask me about valuation - and that’s important too. But it’s not as important as the above. You can overpay for a great business. No doubt, there are plenty of examples of great businesses that took a long time to deliver a decent return because investors bid the shares up so high. But it is a consideration that should be behind quality, as I defined it above.


(The challenge with focusing on valuation is that it shortens your time horizon and forces you to trade. Once a stock is no longer “undervalued” the tendency is to sell it and look for something else that is. Some people are genius at it. But it is impossible to nab a 100 bagger that way. All of the big winners go through long stretches where they never look “cheap.”)


Valuation gets to another favorite question people like to ask me: "How has your investing style changed as a result of writing the book?" The biggest change is this: I used to put valuation first, quality second. Now I put quality first, valuation second. Subtle, maybe. But very important.


I saw all of the above in the context of searching for 100 baggers (or at least multi-baggers over a long time horizon -- say a decade or more). There are other ways to invest well. I’m not saying my way is the best way, or even that you should invest my way. I’m putting forward a style or philosophy of investing that grew out of my work on 100 baggers, seasoned liberally with my own experience and tastes.


You have to invest in a way that’s compatible with who you are. I’ve met people who seem hardwired not to pursue this path. For them, holding a stock for a year is a long time. They’ll pat themselves on the back when they book a small gain and say things like “I sold ahead of earnings. I didn’t want to sit through that volatility.” Or, they’ll buy something and say, “The stock should have easy comps next year and beat earnings estimates.”


Nobody who hunts for big game thinks like this. They take a longer view. Look at Chuck Akre, who figures prominently in the book and introduced me to the idea of 100-baggers in the first place. He recommended Thomas Phelps’ original book on the topic. Akre has had two 100 baggers in his career and a great track record. He rarely sells anything. He buys quality businesses at good prices... and he sits.


Well, that’s enough for today. I hope you enjoyed my reflections on hunting the big game. I wish you the best in your own quest for investing success. Thank you for reading!


***

Published October 20, 2020

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