Updated: Feb 10, 2021
I recently read a very interesting book on how to find hundred baggers. I want to share some lessons on this topic today.
The mystical hundred bagger. This investment can be as elusive as a unicorn yet the history pages full of examples of these kinds of businesses. So exactly what is the hundred bagger? It's an investment that has grown a hundredfold from when you initially invested your capital. Now to think about how astounding an achievement that really is Peter Lynch the famed investor of the Magellan investment funds at Fidelity was framed for looking at 10 bagger investments as a benchmark for success. Hundred bagger is certainly a very rare breed of company. I recently had the opportunity to read a book that was focused just on hundred baggers and distilling the key ingredients that go into making hundred bagger.
I happened to stumble across Christopher Mayer's book on 100 baggers by virtue of some searches that I did for correlation of returns on equity with long term stock performance. This eventually led me to Mayers book via some other resources. This book is fairly unique in my view. Meyer seeks to distill the essential features of businesses that go on to return hundred times their initial invested capital.
Meyer was able to profile the essential characteristics of some 200 or so businesses that returned more than 100x their initial invested capital. The list of businesses included well known names like Monster and Amazon. What did Meyer find were the essential elements of these massive wealth creators?
A focus on growth, above everything else
Growing business generate long term growth for shareholders. Of course that's pretty obvious. But identifying and partnering with a growing business in the early stages of its growth journey tends to lead to significant wealth creation for investors. Revenue growth is generally preferable, because expenses can be optimized around this strong revenue growth. It is often more difficult to go the other way around. Charlie Munger is known for stating that if you buy a business that earns a 6% return on capital, you are unlikely to do much better than a 6% return as a shareholder. However buying a business that earns returns of capital of 18% will lead to a fine looking investment over 20 or 30 years, even if you pay up a little bit for the business.
Thus growth alone, while important, is not the be all and end all. It is important that this growth can make its way through to a solid return on invested capital.
Low Multiples are important
Paying up for a strongly growing business can still get you good returns. However it is unlikely to get you a 100x return on your capital if you pay an expensive multiple for even the best business. This is because the multiple expansion that growing businesses achieve also tends to be an important driver for massive long term returns. Of course, a strongly growing business rarely exists at a low multiple, particularly once the business has been discovered. This is because, such a business will get "bid up" as investors pile in. Thus it goes without saying that small, undiscovered businesses tend to offer the best prospects for 100 baggers.
A solid moat is critical to delivering a 100 bagger. A business only becomes a 100 bagger if it has suitable time to compound invested capital at a high rate of return. The best way to ensure that a business is able to compound capital at high rates for an extended period of time is for the business to have a moat that prevents encroachment by competitors. The natural tendency over time is for businesses to lose the ability to earn excess returns on capital as these excess returns get competed away by new entrants/ competitors in the marketplace. The existence of an unshakeable moat helps keeps these returns in place.
There is something to be said for getting in behind the vision of an owner operator. This is the individual who is the initial founder/CEO who continues to be the driving force behind the business. Owner operator CEO's tend to be rare breed. As a business grows and expands, there tends to be a natural inclination to bring in a business manager to run the business and put in place systems and procedures to operationalize its growth. That can give rise to an agency problem where you have a risk averse CEO with a limited tenure who doesn't fully understand the business and isn't incentivized to take sufficient risk. There is merit to backing owner operators for long term wealth creation.
Leave them alone
Once you find a really successful business with many of the tenets outlined above, a critical piece of the equation is to just leave it alone once it has been invested in. There will be many factors that can influence someone to chop and change a holding. Markets don't move in a straight line, and the amount of volatility inherent in some early stage issues may cause individuals to give them up very early on. It will only be those that have the discipline to stick with these holdings through thick and thin that can truly hit 100 baggers.
Overall, I found Mayer's book a very interesting and refreshing read. I'm still not convinced that you can get a 100 bagger, even if you follow all the points above, without a good dose of luck. Additionally, the pace of technological innovation means that it is far easier to disrupt legacy businesses with much less capital invested. Really successful private companies also tend to remain private for far longer now, in some cases only hitting the public markets as mega cap companies. Facebook, Google, Uber and AirBnB are all good examples of this. Thus for the individual investor, this is easier said than done.
Regardless, I still think Mayer's book still serves as a good blueprint for investors who have aspirations of deriving significant, excess returns on their invested capital.