Spotting Multibaggers in Small Cap Stocks

Everyone loves the idea of earning large amounts of wealth in the least amount of time and  with minimal effort. Some wise men might tell you that such a thing is simply not viable and  that there are no shortcuts in life. However, the stock market will tell you otherwise. The stock  market is a great way to supplement income and sometimes even earn a lot in the least amount  of time with the help of multibaggers. 

What is a multibagger?

A multibagger is a stock that gives returns that are several times over the original value for which it was purchased. These are undervalued stocks which have a lot of potential to rise in  value in the near future. But the question arises of how one could identify such a stock? The  key is to take a deep look into a company’s financial statements and analyse their fundamentals,  their product and the potential that it holds, the kind of management and other such factors. It  is important to look at company oriented, industry specific and economy wide factors. 

A great instance of a person earning great returns through a multibagger is Ramesh Damani, a  legendary Dalal Street stock market investor. He had purchased stocks of United Spirits at Rs. 40 in 2003-04 and the stock rose to Rs. 1400 in 2008. This was when he sold them and gained  multi-bagging returns of about 2900% in four short years. Mr. Damani observed an increasing  trend of consumer demand post the technology boom coupled with the increase in party culture  amongst the youth, he decided to invest in a spirits company. He believed that the demand for  this would surge since he believed that the liquor industry was recession proof. After studying  a number of companies in this industry, he went with United Spirits due to its strong financial  health.  

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Along with a detailed study on the general trends in the economy and the industry, it is crucial  to The important factors that one should look for while looking for a small cap multibagger  stock are – 

  1. Type of Industry

While selecting an industry to invest in, it is crucial to study the general  trends and growth prospects of the industry. An industry which has forward linkages to other  rapidly growing industries has a very high potential for growth. For instance, the chemicals  industry provides base materials to both pharmaceuticals and electric vehicles (lithium  batteries) industries, both of which are rapidly growing and hence, have a great potential for  growth.

  1. Financial Health

It is very important to look at a company’s fundamentals such as current  ratio, amount of debt that they hold, revenues, profit, earnings per share and more. It is  important that the debt of a company does not constitute more than 30% of its total equity. It  should have a healthy leverage ratio (0.5 or less is considered to be ideal). It must showcase  high and sustainable levels of profits and margins. A company which does not exhibit good  financial health at the initial stages will not exhibit a sustainable growth pattern in the future.  

  1. Competitiveness

This is the most important indicator to be kept in mind while finalizing firms to invest in. The chosen firm must have a product that is truly unique in one or the other  aspect and have an edge over its substitutes. Companies with a great research and development  unit have better products in terms of quality and lower costs of production. It is also beneficial  if the country is in such an industry wherein the ease of entry of new firms is very low due to  high barriers to entry. This prevents destructive price wars and increases profits. 

  1. Management
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It is crucial that a company’s management is efficient, disciplined and have the ability to steer the company in the proper direction so as to ensure maximum growth. It is  also important that a retail investor’s goals and the management’s goals align with respect to  the company. Additionally, one should ensure that the company does not indulge in illegal  activities such as diverting the funds invested in the company into other projects and such.  Complete transparency in transactions and deals is ideal. 

  1. Future Growth Prospects

A company with plenty of potential and space for growth has the highest chance to become a multibagger. The company must be able to increase the scale of  production with ease when necessary and invest in growth-fuelling projects which keep up  with current economic trends.  

Overall, it is crucial to study the overall trends in the economy, industry and company wise to be able to pinpoint the most profitable stocks. It is advisable to identify a few stocks whose  companies fulfil the above characteristics and invest in the most promising ones instead of  stacking all your bets in favour of one particular firm. Most of all, it is pertinent to remain patient since it takes some time for these multibaggers to reach their peak.

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