The Art of Picking Huge Winners in the Share Market

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Big winners in the share market are often-termed as “multi-baggers.” That is, shares that have managed to earn X00% and more for its investors. It’s a phrase that is actually coined by investing legend Peter Lynch.

The way to use the term is as such: A 10-bagger would refer to a share that has gone up 10 times in value, or a 900% gain. Meanwhile, a 2-bagger would be any share that has doubled in price, representing a 100% return for the investor.

Finding a multi-bagger may be a dream come true for many investors in the share market. However, it may be akin to finding a needle in a haystack for an investor who wishes to fulfil that dream and yet not know what he or she needs to look out for.

To help you actually find the proverbial needle, here are some of the common characteristics which can be found in multi-bagger shares:

1. A sustainable growth rate

One of Lynch’s criterion to filter for potential multi-baggers is to look for shares where the five-year growth rate in earnings per share (EPS) is considerably high (more than 15% for example) but below 50%. The reason behind his thinking is that earnings’ growth rates that are too high – like 50% – are not only unsustainable, but would also attract intense competition.

Hence, he came up with that sweet spot of not-too-high, and not-too-low.

2. Efficient management

Perhaps one of the most essential requirements for a share to be a potential multi-bagger is the quality of its management. No matter how great the quality of a company’s business is, its long-term fate would still falter in the hands of inept management.

Some of the best tools to gauge management efficiency are to consider how they utilize their capital and whether they manage to deliver on their plans. Attending AGMs (Annual General Meetings) and asking questions can also be  a good way to ascertain whether a company’s management team is led by people whom you can admire and trust. Observing their body language can sometimes give you a gut feel on whether you can trust them too.

3. Strong financials

Apart from a strong growth rate, a truly great company will also exhibit further strengths when it comes to other aspects of its financials.

It’s desirable to see a company have lower debt to equity ratios, stronger profit margins, and higher returns on equity (ROEs) as compared to its competitors. Such traits are a sign that the company may be poised to grow steadily over the long haul.

4. Competitive advantages

A company with a sustainable competitive advantage would deter competitors from assailing its profits. Such companies are able to protect and grow their profits and hence would see their share prices increase over time as well.

Being the only stock exchange operator in town confers some strong competitive advantages to Singapore Exchange (SGX: S68). It’s thus no real surprise to see shares of the company gain 310% (that’s slightly more than a four bagger!) to S$6.93 currently since the start of 2004. In the process, it has shown the Straits Times Index (SGX: ^STI) a clean pair of heels with the market barometer gaining just 85% to 3,263 currently.

Foolish Bottom-line

All said, it is important to note that holding on to potential multi-baggers often requires a great deal of patience and contrarian thinking before those shares fulfil their potential. In fact, it’s not easy to resist the urge to sell each time a share hits a new high as it goes from being a two-bagger to a 10-bagger; the emotional forces at play can be really strong in those times.

Lynch once wisely quipped that “Everyone has the brain power to make money in stocks. Not everyone has the stomach.” Can you handle your emotions en-route to earning your 10-bagger?

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The information provided is for general information purposes only and is not intended to be personalised investment or financial advice. Motley Fool Singapore contributor James Yeo doesn’t own shares in any companies mentioned.