Unique Research - Wouldn’t it be nice to invest in a 100-bagger?
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What is a 100-bagger you ask? These are stocks that return $100 for every $1 invested. That means a $10,000 investment turns into $1,000,000. Sound ridiculous? It has occurred more often then you might think. The real point, however, is the quest for finding companies that exhibit characteristics conducive to this type of growth. Luckily, we have an expert that can assist in this endeavor. Chris Mayer (Alpha Ring Manager and Chief Investment Officer of Woodlock House Family Capital) conducted a study searching for those USA stocks that grew over 100 times between 1962 and 2014. Mayer’s work resulted in a list of 365 companies and his complete analysis is available in his 2015 book entitled “100 Baggers Stocks That Return 100-To-1 And How To Find Them.” In addition to being a portfolio manager, Chris is an accomplished writer having published four books and written two popular investment newsletters. As the NS Capital Investment Committee is asking our Alpha Ring managers to identify these types of companies, we thought it might be interesting and informative to get his unique perspective from the study. Below are key highlights from Todd Peters, Chair of our Investment Committee, conversation with Chris on October 13th.
What was an interesting observation from the 365 companies that made your list?
I would have to say the diversity of industries represented. I think one might have thought the list would be dominated by technology companies, but it certainly was not. The 100-bagger population seemed to favor no industry. There were retailers, beverage makers, food processors, tech firms and many other kinds. Kansas City Southern, a railroad stock, was up more than 16,000-fold since 1974. A $10,000 investment there turned into $160 million in 40 years. I would never have guessed a railroad stock would be near the top of list.
What does that diversity tell you?
It tells me that it is much harder to try to guess what is going to be “the next big idea.” It is better to see which company has the highest return on its capital. That is a better gauge.
So, return on capital is the key financial metric?
It is important to determine what return a company is getting from the capital deployed but I believe it goes beyond that. One needs to take it another step by asking how much of that return is getting re-invested back into the business. In a perfect world, it would be fantastic to see a company that is achieving a 25% return on its capital to completely re-invest the profits back into growing the enterprise. That is not easy to find but is worth searching for.
What are some of the non-financial characteristics that are important to identify?
Yes, you are correct, there is a qualitative component that is critical. I would say some of the key observations included:
§ Insiders and employees owning a meaningful amount of company stock
§ Compensation incentives based per-share measures…such as free cash flow per share
§ An established system of decentralized decision making
§ A competitive position that can be maintained and…ideally…expanded
§ Management that is willing to adapt and be flexible to lookout decades…rather than quarters
Obviously, there are others, but these characteristics stood out from the list and should be central to the analysis process.
Did you have to invest in the tiniest companies to achieve 100-bagger status?
No, not at all. The median sales figure for the 365 names at the start was $170 million and the median market cap was $500 million. So, it dispelled the myth that to get a 100-bagger you must start with tiny companies. $170 million in sales is a substantial business in any era. It is not a tiny 50-cent stock with no revenues.
What is the biggest hurdle to achieving a 100-bagger?
I would have to say patience. The amount of patience required to maintain an investment is enormous. The path to 100-bagger is never straight up. In fact, there can be both significant drawdowns as well as extended periods of no returns. For example, from 1965 to 2014, Berkshire Hathaway returned 18,261%...tops on the list…yet, during that period, the stock price declined over 50% three times and went basically sideways for seven years at one point. Not many investors could withstand that. So, I would have to say patience.
How long did it take to achieve 100-bagger status?
There was a very wide range. The shortest time was 4.2 years and the longest was 52.5 years. The average was 26 years. 80% of the list reached 100-bagger status between 16 to 45 years. Again, emphasizing the need for patience.
Has the analysis had an impact on how you invest today?
It absolutely has! And the impact has grown more powerful over time. I have re-thought what is important about investing. In the beginning of my career, I used to believe that valuation was most important. I would always start with valuation. Following the study, I realized that I needed to nail down the business quality first. How does the business create value? How are they reinvesting profits? This has become paramount before I look at valuation. My focus is now on high-quality companies that can compound over time.
I wish I had this knowledge a lot sooner! No, seriously, I guess my closing thought centers on the two critical questions to answer. Is this really a good business? Can I see myself owning this company for a decade or more? It takes a significant amount of work to effectively answer those questions, but it is that simple. That is starting point on the 100-bagger path.