Finding a tenbagger, a stock that returns ten to one, is like finding a big lump of Gold in the Mississippi, in the late 1800s. But perhaps surprisingly is that tenbaggers are quite often dwarfed by their big brother, the 100 bagger. Stocks that return 100 to one.
When Peter Lynch coined the term tenbagger, he was describing a stock that returned ten times its value. But a 100 bagger returns ten times that.
To find these stocks we can use a few books and some research of our own, to study what most 100 baggers looks like and what they have in common. The book “A 100 to 1 in the stock market”, by stockbroker and investor Thomas William Phelps, from 1972 , and Chris Mayer’s more recent book “100 baggers: Stocks that return 100 to 1 and how to find them”, are good starting points.
What is a 100 bagger?
A hundred bagger is a stock that increases its value a 100 times over. Or in other words a return of 100 dollars for every one dollar invested. That means a 1000 dollars invested at the start of its journey turns into 100 000 dollars at the end of 100 baggerdom.
100 bagger common traits
In Chris Mayers’s book he looks at every 100 bagger, between 1962 and 2014, and what he found was that 365 companies had made this journey. This might be a bit surprising, since it is the exact same number that Thomas Phelps found, when he studied stocks between 1932 and 1971, more than 40 years earlier. Further, most 100 baggers share a few common characteristics which are investigated below.
A company needs to have an extended period of high growth to become a 100 bagger. The average time-period, to become a 100 bagger, was 26 years, in Chris Mayer’s study. But interestingly, some stocks became 100 baggers in a much shorter timespan.
PE ratio expansion
According to Phelps most big stock price increases arises from increasing earnings alongside an increasing PE ratio. Because when they are both rising sharply, at the same time, the stock price explodes. A stock can increase a hundredfold if its earnings increases twenty-five fold in the same time period that its PE ratio increases by a factor of four. (25*4=100). Take Amazon as an example. Its PE ratio has averaged over a 100 in the last years. And it is actually now well above a 2 500 bagger, since it was listed in the nineties. But its PE ratio started out low.
PE ratio expansion happens when the growth and expectations are high. Therefore a future 100 bagger should ideally be bought at a low PE ratio. Preferably 15 or lower. But there are cases where the PE has been quite high as well. But where the stock had a lot of runway to grow into a 100 bagger, despite the high PE ratio. Amazon might be the best example of that, since its stock could have been bought at a high PE for a very long time of its History, but still became a 100 bagger many times over after that point.
In Mayer’s book he concludes that out of the 365 businesses the median market capitalization at the beginning of the rise was around 500 million dollars. A 100 bagger needs room to grow. As a result they usually start of small, growing at the local level, and later expands its growth internationally.
Smaller companies are of course riskier than their larger counterparts. But they are likelier to become 100 baggers, because of their longer runway. Of course they also bear the risk of failing completely or to go bankrupt. Therefore you need to know what you are doing if you are looking for 100 baggers among these stocks.
Amazon has not reported a profit up until recently, since much of its growth came from its reinvestment into new research, development and marketing. Amazon could have paid out a great dividend for many years. Yet it kept, and still keeps, increasing shareholder value by reinvesting that capital instead. And this high return on invested capital is quite common for 100 baggers. Often they don’t pay out a dividend because the company knows how to allocate capital into new investments.
Dividends and growth
“It is simple arithmetic that a company with a book value of ten dollars a share earning 15 percent on its invested capital will have a book value of 11.50 a share at the end of one year if it pays no dividends. At the end of the second year its book value will be 13.22 dollars and at the end of the third year 15.20 dollars. In five years the company’s book value will have doubled. In thirty-three years it will be up one hundredfold. If the same company pays out a third of its earnings in dividends, reinvesting earnings at the rate of ten percent of its book value each year, its book value will quadruple in fifteen years instead of ten.” – Thomas Phelps, 100 to 1 in the Stock Market.
There is a case to be made that less dividends does not automatically give the investor more money in the pocket in the long run. A dividend growth strategy might work just as well, if you pick the right company that is.
A good example is Warren Buffett’s investment into See’s candy in 1972. Because See’s candy haven’t grown much since it was bought by Buffett, but still has made huge sums of money for its owner, through dividends, coming from its huge free cash flows. The takeaway is that when a business keeps cash from its owners, it better have a good reason for it. A good reason could be that it has a competent management which knows how to allocate capital. As is the case for Amazon.
As we shall see, in part two on 100 baggers, return on investment is the real reason why Jeff Bezos has been vital to Amazon’s success. Because Jeff Bezos is what Warren Buffett would call an “owner operator”. This means that he runs the company and at the same time is the majority owner. This is good for shareholders because high insider ownership will often protect against fraud. And it also makes sure that the company outperforms. Owner interests are aligned with shareholder interests.
Gross profit margin
According to Mayer a higher than average Gross profit margin was one of the universal traits for the 100 baggers he studied. And for some reason companies with higher than average gross profit margins seems to be more resilient in other ways as well. Often they have higher margins across the board, because of their higher gross profit margin. Also, over time these companies kept their higher gross margins.
Companies that become 100 baggers usually have what Warren Buffett would call a “moat”. A moat is a protection against competition. For example, it could be a patent, a geographic location, a secret process or a brand name. One obvious example of a moat is the Coca Cola brand name. But a moat could also be an unofficial monopoly of some sort. For example the company could own the only railroad that goes through a certain area. Kansas City southern is an example of such a railroad. It is a 100 bagger many times over. It has a virtual monopoly on the railroad freight between Mexico and the United States.
Kansas City Southern owns a small route and is one of two major companies that have cross border rail connections between Mexico and the United States. It has a 50 year concession granted by the Mexican government to operate that railway. The route has been well-placed to take advantage of NAFTA trade and has increased enormously in value since 1974. It is a 100 bagger many times over and even north of a 16 000 bagger today. And even if you had bought it as late as 1997, you would have still made a 100 bagger on it up until now.
Buffett has said in the past that he thinks that share buybacks are beneficial when they are done below intrinsic value. But that they can also ruin a company if done on overvalued levels. Therefore share buybacks on undervalued price levels are often a sign of competent management. While buybacks at high levels are a sign of the opposite. Many 100 baggers have done share buybacks successfully, on undervalued levels.
Acquisition through your own stock
According to Thomas William Phelps, most 100 baggers have good managements. Often these managements acquired other companies at lower multiples, than what their own companies were worth at the time. Some of them did this by issuing stocks from their own company, when it was overvalued, as payment for the companies that was being acquired. This strategy has been used by among others Jeff Bezos, who have used Amazon stock to acquire other businesses, when he thought Amazon’s stock was highly valued. This strategy means the company essentially is buying the other businesses on sale.
Discovery exploration stocks
Discovery companies are also mentioned in Phelp’s book. Discoveries in the Gold, Oil and natural resources space can make a stock price soar a hundred times over, if that discovery is good enough. And although these companies often enjoy a great deal of luck, the ones that hit the jackpot often have great managements. Therefore it is smart to invest with the guys that have done major discoveries in the past, to increase the chances of a jackpot, in the Discovery exploration stocks.
New inventions and monopolies
A 100 bagger can also be created by new inventions, processes and ideas. Apple and Microsoft are examples of that. But also companies that get contracts from governments to do monopoly type like business for a certain amount of time. For example, the monopolised building of facilities or big infrastructure projects can be very profitable.
Earnings are the reported profits of a company. But the “earnings power” refers to the inherent power of a business, to create the earnings, necessary for growing it into a 100 bagger. It is the return it has on invested capital, cash flows, margins, sales growth and how the capital structure is constructed.
Examples of earnings power differences
Two companies could be earning ten dollars a share and both could be paying out five dollars a share in dividends. But only one of them is increasing its sales by ten percent a year. That means that the earnings of those two companies are not created equal. Even if it looks that way on the surface, which is important, because it can separate a 100 bagger from a mediocre company.
The former company obviously has something going for it. Maybe it has reinvested its capital at a higher rate, which often can be seen in the numbers. Or it has been able to cut costs or raise prices. Needless to say the other company might have sold some of its assets or taken on more debt, to keep their earnings as high as the other company’s earnings. And that is the reason why it is important to “Look through earnings”, when doing fundamental analysis.
The first company might spend a lot of money on research and development. And therefore it looks like its earnings are the same as the other company’s earnings that spends nothing on research and new inventions. Either the company could get good returns on its research in the future, or in the worst case scenario it could cut down on their research. And when they cut that research they will usually increase their pretax earnings. Again, showing that all earnings are not created equal. Oftentimes the company that is doing reinvestments is in a stronger position. It often depends on the management.
What is interesting about Phelps is that he also used charts to complement his fundamental analysis. And he describes technicals as a way to get additional information about the fundamentals. For example, it is very hard to know all that is to be known about an investment. And therefore charts can help to warn us if something is wrong, according to Phelps.
“It seems to me important for the professional investor to know at all times not only what ought to be happening in the stock market, as determined by fundamental security analysis, but also what is happening in the stock market, as determined by technical work.”
But according to Phelps charts should not be the main framework on which you build your investment thesis. Because it can make you lose sight of the underlying fundamentals. And it can make you overtrade or sell a good stock too early. Or simply make you forget about “buying right and holding tight”. And that is why we should never ignore the fundamentals.
Buy right and hold tight
“Buying right will do you little good unless you hold on. But holding on will do you little good – and may do you great harm – unless you have bought right.” – Thomas Phelps(LÄNK)
The words above are filled with wisdom. But how do you buy right and hold tight? To buy right you first need to find the right stock. This is actually probably the easiest part. Because holding tight year after year might be harder than you think. And to be able to hold it tight, and wither out all the storms, you need to know enough about the investment to not let it go when it is faced with difficulties. For that reason, the calculation of its intrinsic value is key.
According to Phelps the little man has an advantage over the big guy on Wall Street. Because he does not make any noise. And noise is what scares of the big elephants. Therefore a poor man can make big money on Wall Street if he does his homework. But he needs to stay with the right stocks and not stray from the course and only invest in the very best names to score a 100 bagger. A quote from Thomas Phelps summarizes this well:
“When I was paving my way through equatorial Africa by shooting elephants for ivory, I learned this simple principle: When looking for the biggest game, be not tempted to shoot at anything small. Elephant ears are very keen. Never after firing a single shot at a Guinea hen, a colobus, monkey or an antelope did I see an elephant that day.”
To see more 100 bagger examples, stay tuned for part two of this post.