A few exceptional stocks can power a portfolio’s long-term returns, but finding the next multibagger takes patience, discipline, and a clear focus on quality, profitability, and price.
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Following an excellent 2018 book by Christopher W. Mayer, 100 Baggers: Stocks That Return 100-To-1 and How To Find Them, a recent article by Anna Yartseva has advanced the knowledge of the characteristics of top-performing stocks and updated it to a more recent period. The investment term “baggers” or “multibagger” was borrowed from baseball, referring to the “bags” or “bases” a player reaches after an at-bat; for example, reaching second base is a double-bagger.
Hidden Stock Market Math
Beyond the obvious fact that investors prefer multibagger returns to losses, there are additional reasons to be interested in the characteristics of high-performing stocks. The US stock market has historically had a shocking number of losers. According to a fascinating paper by Hendrik Bessembinder examining the returns on 29,078 U.S. stocks from 1926 through 2023, over half of all stocks, 51.6% to be precise, had negative cumulative returns. How does the stock market have a close to 10% long-term annualized return while more than half of the publicly traded stocks fall in value?
The complex mathematical answer is that stock returns have strong positive skewness. However, a simple example of long-term positive compound returns provides an easier-to-digest answer. Take a portfolio of just two stocks selling for $100 per share. The first stock grows at 9.8% annualized, while the second stock falls by 9.8% annualized over thirty years. One would think our total portfolio would stagnate during that period, since losses in one stock would offset gains in the other, but compound returns make that intuition incorrect. The exponential return on our positively performing company outweighs the losers. This portfolio grew to $1,657, yielding a 7.3% annualized rate. In other words, the highest-performing stocks more than compensate for the losers over time.
The Magic Of Compound Interest
Glenview TrustImplications For Investors
In his book More Than You Know, Michael Mauboussin notes that “the frequency of correctness does not matter; it is the magnitude of the correctness that matters.” The dollar change in a portfolio counts as success in investing, not the percentage of stocks with a positive outcome. Much like the stock market as a whole, a successful investment portfolio typically has exceptional stocks that more than overcome the subpar returns of the duds.
Mauboussin notes that investors must consider probabilities when investing in a stock, since significant losses and a few winners are likely drivers of investment success and failure. He quotes the late, great Charlie Munger speaking about the thought process of Berkshire Hathaway’s (BRK/A, BRK/B) Warren Buffett, “Take the probability of the loss times the amount of possible loss from the probability of gain times the amount of possible gain. That is what we are trying to do. It’s imperfect, but that’s what it is all about.”
According to Howard Marks, Warren Buffett, the greatest investor of all time, is credited with just twelve sensational winners in his career. Charlie Munger told Marks that the “vast majority of his own wealth came not from twelve winners, but only four.” The key was to find and hold onto those winners while avoiding significant losses. While Buffett began his investing career buying “cigar butts,” low-quality but cheap companies with one more “puff” left in them, he evolved to focus on long-term ownership of higher-quality companies with Munger’s influence. Buffett now says, “It’s far better to buy a wonderful company at a fair price than a fair company at a wonderful price.”
Findings from Mayer’s 100 Baggers
Mayer studied companies that went up 100 times. His work argues for a view similar to Buffett and Munger’s, that the secret to these compounders is owning exceptional businesses for a very long time. Among the characteristics that Mayer believes are important ingredients for exceptionally performing stocks are: high returns on capital, long growth opportunity, ability to reinvest at high returns, smaller starting size, and a robust competitive advantage.
The Alchemy of Multibagger Stocks
Yartseva’s more recent study examined NYSE and NASDAQ stocks over the 15-year period from 2009 through the end of 2023. This period was at the end of the global financial crisis (GFC), but it still included two recessions and three bear-market stock declines. During the period, Yartseva found that 537 companies saw their stocks become 10-baggers, rising to 10x the original price or a 900% increase. Stocks that temporarily reached the tenfold level but later dropped below were excluded from the analysis.
The Big Picture
Yartseva’s 10-baggers rose by an annualized average of 21.4% during the period, while the S&P 500 gained 11.7%. The top ten stocks had a compound annual growth rate of 37.6% during the period.
Stock Appreciation (2009 – 2023)
Glenview Trust, Yartseva, Bloomberg
The sector exposure of the ten-baggers was very diverse. While the technology sector had the most multibaggers, the industrials and consumer discretionary sectors were very close behind. The bottom three sectors with the fewest big winners were real estate, energy, and utilities.
Multibaggers By Sector
Glenview Trust, YartsevaDefining Characteristics of Multibaggers
The median annualized revenue growth rate was 11.1%, while earnings per share was 20.0%. This is interesting because some investors believe that ultra-high growth rates are needed for exceptional stock price performance.
Multibagger Characteristics (2009 – 2023)
Glenview Trust, Yartseva
While this study found that a smaller company size was suggestive of higher returns, all things being equal, the extent of the impact was less clear. While not part of the paper’s findings, it might be suggested that the rise of the mega-cap technology companies, which deliver little in the way of physical goods with massive earnings leverage at scale and benefit greatly from network effects, adds to the uncertainty about the size argument.
Profitability was found to be a significant factor. Higher return on assets (ROA) was consistent with higher future stock returns. Since many “quality” investors emphasize profitability, this is good news.
Based on a famous study by Fama and French, higher year-over-year growth in assets, which implies corporate spending or capital expenditures (capex) on assets, implies lower future stock returns. The explanation is that corporate management can often be overly optimistic and might invest in a project that doesn’t deliver the projected earnings growth. Yartseva found an important distinction regarding investment growth. When asset growth exceeds earnings before interest, taxes, depreciation, and amortization (EBITDA) growth, stock returns tend to be negatively affected. In simpler terms, companies must invest to support growing earnings, but investors tend to punish companies that invest faster than they grow earnings. The current market struggles with the massive capital expenditures (capex) by the artificial intelligence (AI) hyerscalers makes good sense both logically and in light of this analysis, as it will matter if the companies can earn a proper profit on these investments.
Interestingly, despite sales and earnings growing at double-digit rates for the multibaggers in the study, growth in EBITDA, earnings per share (EPS), or free cash flow (FCF) per share was not indicative of higher stock prices. While this may seem shocking, the most important variables found by Yartseva are informative. The value factors of book-to-market (B/M) and free cash flow to price (FCF/P) had the most important role in explaining future stock returns. This finding indicates that it matters what you pay for growth to be an exceptionally performing stock.
The Wisdom of Warren Buffett
An innovative analysis of the source of Berkshire’s investment performance showed that Buffett’s “focus on cheap, safe, quality stocks” was a primary driver of his outperformance, and Yartseva’s work indicates that this likely remains an excellent investment framework. In investment terms, quality stocks typically have persistent high profitability. Despite the incorrect view by some that Buffett only buys cheap, value companies, the reality is that he values growth but is mindful of how much he pays for expected future corporate profits. Buffett has said that “intrinsic value can be defined simply: it is the discounted value of the cash that can be taken out of a business during its remaining life.” This statement aligns with Yartseva’s assertion that free cash flow, a measure of cash that can be taken out of a business, is a crucial driver of future stock returns.
Selecting Stock Investments
One implication of this study is that those studying and implementing the Warren Buffett and Charlie Munger investment framework of looking for high-quality, profitable companies at a reasonable price and holding them for a long time are likely on the right path. It is worth repeating Buffett’s warning, though: “Investing is simple, but not easy.” Yartseva’s study adds that multibaggers are often subject to rapid price declines at times, despite their long-term outperformance. Furthermore, the best time to purchase them is when they are close to their 52-week low and have fallen sharply over the previous six months, which is much easier said than implemented, since these price declines are typically accompanied by concerns over the company’s future business prospects.
For those not in a position to select individual securities, there are ways to harness this powerful investment framework in an inexpensive and simple way. The Avantis U.S. Equity ETF (AVUS) owns stocks across all U.S. market capitalizations. The maximum individual security weight is 3%, except when the index’s market capitalization is higher. In any case, the ETF will remain very diversified and less top-heavy than the index. Their investment process tilts toward the two factors that should drive long-term outperformance: valuation and profitability. The analysis of the AVUS ETF from 2022 held up over time and provides more detail about its investment process. AVUS has very reasonable internal expenses of 0.15%, while the ETF structure should limit any capital gains distributions for taxable investors. As a proof of concept, AVUS has outperformed its benchmark (Russell 3000 index) over the past 5 years, despite operating in a technology-dominated, growth market.
Disclosure: Glenview Trust holds Berkshire Hathaway as part of its recommended investment strategies. The author is a long-time shareholder of Berkshire Hathaway and worked for Salomon Brothers when Warren Buffett became Chairman and CEO. Glenview Trust currently has the Avantis U.S. Equity ETF (AVUS) and other Avantis ETFs on its recommended investment platform. Neither the author nor Glenview Trust receives compensation for writing about or recommending any specific stock or ETF.