Investors share a common goal; buy low, sell high and make a good profit. But what gets the heart really racing is that realization that you’re on to something big: a share than doubles, triples or, better still, becomes a mighty 10-bagger.
For the uninitiated, 10-baggers are shares that make you ten times your money, so let’s assume you buy a share at 100p. Up it goes, all the way to £10. That’s a 10-bagger. OK, for the pedants among you that's actually a 9-fold rise not 10, but let's not quibble. The term is another of those sporting cliches that has found its way into City-speak via Wall Street thanks to its origins in America’s national past time – baseball (it refers to going round the ‘bags, or bases as we might say, implying a home run.)
10-bagger Lynch
The term was popularised within the investment community by former fund manager Peter Lynch, or 10-bagger Lynch as he became known in financial circles, due to his astonishing success running Fidelity's Magellan Fund between 1978-1990. The fund started out with assets of about $20m but ended up, 12 or so years later, worth $14bn thanks to his ability to spot 10-bagger after 10-bagger.
Cynics might argue that such success is only possible for fund managers with their reams of financial data, and army of analysts to process it all. But spotting these potential shooting stars in the first place is not necessarily an investor’s biggest problem, it is rather the twin threats of short-termism and simple human nature.
In most cases it will take several years for a growth story to develop sufficiently to unlock the full share price profits potential. That takes an awful lot of patience on the part of the investor, and an iron will to avoid selling too early.
Changing habits
Luke Johnson, chairman of Channel 4 until quite recently, has enjoyed his fair share of 10-bagger success over the year, most famously as one of the original investors in the Pizza Express chain. Back in the 1960s, when the chain was established, eating out in restaurants was a rarity for all but a handful of people. But shorter working hours and better pay have turned what was once an occasional luxury into something that many of us do so often these days that we take it for granted.
The key for Pizza Express was establishing a clear brand to meet this change in habits, often becoming the one upmarket eatery in market towns up and down the country. But it still took years to develop into the 500-odd strong chain it is today and create the vast profit multiples for Johnson and his chums.
Sell-by date
And not every investor can hang on in there long enough. For example, just think back to the last time one of your shares doubled in value. How tempting was it to sell up and lock-in that fabulous 100% profit? This is the human nature part of the problem. Clearly, if a share is to blaze its way to 10-bagger territory it will offer many profitable opportunities to sell, perhaps when it doubles. Obviously, locking a profit is never a bad thing but it can be frustrating to sell too early instead of backing your original enthusiasm, and this temptation needs to be overcome to bag those really big profits.
The other issue is of one of horizon. Many investors are only prepared to look as far as they can see, and that usually means anything from a few months to perhaps 18. In share price terms it is usually about as far forward as most forecasts can offer sensible guidance. You'll seldom see a hedge fund, which trades its stakes every few months, milk a 10-fold share price increase.
Where to start?
So where will we unearth tomorrow's 10-baggers? Recovery stories are always an interesting area, and stock ideas regularly stem from the holdings of UK special situations funds, which you can find on trustnet.com. The junior AIM market is another obvious hunting ground. Yes, being easier to list on AIM does mean there is a lot of over-hyped, speculative froth, not to mention some down right rubbish. But it has also developed into a genuine market to find small, young and exciting growth stories, the type that could really set the world on fire in future. 'Elephants don’t gallop,’ Peter Lynch famously said, implying that big companies don't have big stock moves - the biggest moves will inevitably come from smaller companies. In other words, be realistic. You are far more likely to see a company, worth £10m today become worth a £100m tomorrow, than you are to find a £1bn firm becoming a £10bn one.
Similarly, 10-bagger potential is likely to be found within certain sectors. AIM is awash with small oil and gas exploration companies and mini mining firms thanks to the soaring price of oil, gold and other hard commodities over the past few years. UK biotech offers similar dynamics to the resources sectors in that one new wonder drug can transform a stock market minnow virtually overnight in much the same way that an oil strike or new gold seam discovery can.
The next blockbuster is just around the corner, you just have to look out for the signs – a niche but valuable product, a genuine growth market, or a recovery about to kick-start. Tomorrow's 10-baggers have already started their journey, you just have to hitch the right ride.
10-bagger tales from the past:
WS Atkins and Cairn Energy
One was a seemingly dull Epsom-based engineering and construction contractor, the other an exciting oil explorer in India full of the frontier spirit. WS Atkins and Cairn Energy wouldn't appear to have very much in common, beyond perhaps a certain familiarity with drills and diggers and, at the time, both being constituents of the 250 mid-cap index. And their 10-bagger success.
Cairn has been one of the great oil discovery success stories of recent years. It paid just £7m for exploration acreage in Rajasthan, India, but has since reaped huge rewards thanks to a billion barrel discovery on its three key oilfields - Mangala, Bhagyam and Aishwariya. Soaring oil prices and implied future cashflows saw investors chase the shares to incredible levels. In early 2003 you could have bought stock for about 25p. Just 3 years later they shot over 250p, and have kept going to over 400p earlier this year, thanks in part to its 31 per cent exploration stake sale which netted a £480m cash return to shareholders.
The Atkins story was a different kettle of fish. For years a rock-solid construction and services company - and consistent share price performer – until it discovered PFI (private finance initiatives) in 2002. This saddled the company with crippling debts and forced it to axe the dividend after falling £33m into the red. Ironically, the straw that broke this camel’s back was its ability to botch a new IT billing system which meant customers were simply not asked to pay up on contracted work.
Yet swift management action and continued revenue growth triggered a sharp rebound, both operationally and in the share price. This meant that the shares, which bottomed out at just 52p in late 2002, had almost become a 10-bagger by the end of the following year. The stock has since gone on to hit pre-recession highs of over £12, and currently change hands for 674p.
Contrasting they may be, but what both of these stories tell us is that 10-baggers are as likely to be born from the dull and dreary, as from the supposedly sexy end of the stock market.
Talking turnarounds:
The four signs for spotting a possible 10-bagger recovery play
1: Decent products
Focusing on struggling companies that produce a decent underlying product has a two-fold benefit. First, the company is more likely to continue selling the product, and thus keep cash coming in, which can itself be the difference between survival or not. Second, there's always a chance a rival may want the product for itself and attempt to get hold of it on the cheap with an opportunistic bid. If a product is too easily replaced by someone else's, avoid it. Nervous customers and suppliers may jump ship and push the company deeper into trouble.
2: One-off problems
There's always a much better chance of a turnaround if it is a single, clear and solvable problem in the first place. They are much easier to sort out with swift action. It is also important that there is clear evidence that sales growth has not gone off the rails completely. A company may have seen its profits wane because of shooting costs, but this is often a short-term consequence of expansion, and by and large, is reasonably easily solved. It is much easier to make life saving cuts to a rising cost base than it is to suddenly turn on the revenue tap. On the other hand, firms warning on profits following a slump in sales should set alarm bells ringing since this is often the first sign that a company has lost its previous edge over the competition. Unless the company has a proven record of surviving previous industry cycles, these type of firms should be avoided.
3: Fresh management
New management is often the key catalyst to a recovery story. They're not hindered by the emotional baggage of the previous bosses and, as outsiders, generally they find it far less troublesome to take the necessary action to spark the turnaround. New brooms have no sacred cows. Peter Lynch once said, 'go for a business that any idiot can run - because sooner or later, any idiot probably is going to run it.' Clearly, bad businesses in poor industries will be perpetual underperformers no matter who is in charge.
4: Cheap valuation
The shares must have plenty of upside potential if you're going to take on the added risks that come with a recovery story. Current earnings are often useless as a guide in most recovery situations, since profits are likely to be either heavily depressed or completely non-existent. It's always worth applying a bit of common sense to work out what the future profits prospects of a company might be. Look at the current sales, profits and operating margins to make a sensible stab at what these respective figures might look like post-recovery. That way, you can make a reasonable estimate on future earnings and work out what sort of forward PE the shares are be trading on, and importantly, what the PE might rise to once recovery really starts kicking in. Look for single-digit PEs now that could turn into double-digit ones over the medium-term. If it comes off, you'll get the double-whammy of a decent rise in profits plus an upward re-rating of the shares. For example, a current 90p share price on 15p EPS would mean a PE of 6. If you get your sums right, EPS could rise to 18p (20% increase) and spark a PE of 10 – that would mean 180p shares, twice the original amount, and well on way to 10-bagger country.
