What are Multi Bagger Stocks- Definition & Reasons to Invest

What are Multi Bagger Stocks?

Multi bagger stocks are equity shares of companies that offer returns several times of the stock prices. Such stocks can be seen in high-growth industries, however, only a few stocks can be multi baggers that help to improve portfolio returns. Companies that have good fundamentals, strong management and corporate governance practices, and whose stock prices are relatively undervalued, tend to have Multi bagger stocks.

How to identify if a stock is a multi bagger?

There are various ways of identifying stocks that have the potential of becoming a multi bagger in India. One of the most important ways of analysing and identifying multi-bagger stocks is to look at the company’s future earnings growth. A company’s historical growth must be taken into consideration to project future growth prospects. 

Most Multi bagger companies depict similar characteristics with regards to company and financial aspects. Here are some common guidelines that can help an investor in identifying a multi-bagger stock:

• Industry with strong growth potential: An industry that has the potential to achieve multi-fold growth in a 5-10-year horizon may have multi bagger stocks.
• Limited debt: A company’s borrowings must be considered while identifying potential multi baggers. Financial leverage can be identified by looking at the debt-to-equity ratio. This ratio is calculated by dividing the company’s liabilities by shareholder’s equity. The ideal debt-to-equity ratio should be under 2.0. A debt-to-equity ratio of 2.0 indicates that a company is able to finance its capital using 67% debt and 33% equity.
• Competitive advantage: Apart from fetching above-average profits, a business’s sustainability is important to focus upon. With competitive advantage, a company can achieve sustainable high-profit growth. With the help of high market share through a strong brand presence, lower input costs, and a distinct product line, a company can achieve competitive advantage.
• Strong management: Corporate governance practices of a company are mostly underestimated by investors while choosing the right stocks. A potential multi bagger stock should have a capable management that reflects high integrity. The management’s strength can be gauged through the level of independence enjoyed by auditors and board of directors, the net value of shares pledged, the number of related party transactions, etc.
• Reasonable valuations: A good company does not always translate into a good stock. A PE ratio that grows faster than the stock price can be used as one of the indicators of identifying a potential multibagger stock.
• Strong earnings growth: A company’s earnings growth can best be gauged using the Earnings per share (EPS). EPS tells us the portion of a company’s profit that has been set aside for each share and is calculated by dividing the net profit by the total number of shares outstanding.

Reasons to invest in multi bagger stocks

Multi bagger stocks have the potential to substantially increase an investor’s wealth since these can bag exponential returns. Investors who are looking for substantial wealth creation and can take on higher risks can invest in multi bagger stocks. These stocks may not always give dividend income, therefore, investors who want regular income through their investment may not benefit from multi bagger stocks.

Risk factors of multi bagger stocks that investors should know

Before investing in potential multi bagger stocks, investors should know of the following associated risks:

• Lower liquidity: Oftentimes, incomplete or insufficient information and a greed to make quick money may result in liquidity risks. This is rarely the case with stocks whose price discovery has not been made by the markets.
• High reliance on stock tips: While investors should look through genuine research reports before picking stocks for investment, depending heavily on these can prove to be risky. It is advisable to go by own analysis as compared to purely basing an investment decision on stock tips from anonymous sources.
• Uncertainty: There are lesser chances of higher rewards from all the identified potential multi bagger stocks. Due to the uncertainty of whether markets will discover the expected price of the stocks, investors stand a chance to lose their investment value.

Investing in a potential multi bagger stock requires patience and the investor’s ability to hold the investment through market volatilities, since the company may take many years to establish itself as the sector leader. 

Conclusion

Investment in multi bagger stocks should be held for the minimum duration to ensure sufficient capital gains. While it is tempting to look for multi bagger stocks, investors should also limit the investment proportion in potential multi baggers such that it does not impact the overall portfolio in case of loss or insufficient gains.

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