The Business Models of Potential Multibaggers
Below you can review a basic model of a company’s lifecycle. This relates to the matrix you may have read about in our previous series on the Financial Engines behind Multibaggers.
At the beginning of a company’s journey, they often start out as speculative ventures. This period is often characterised by high growth but low profitability and significant startup capital investment. It is highly unlikely to see any payouts to shareholders at this phase of a company's progression.
But if they grow out of that phase, they may become compound growers. This period can see high growth, growing profitability, but still quite low shareholder payouts due to the high reinvestment of excess profits.
As they come to the end of the growth runway, they will become more like cash cows - slower growth, higher profitability with low reinvestment of the excess profit they make, which allows higher payouts for their shareholders - as dividends or buybacks.
If competition comes in, and they no longer sustain that competitive advantage, they may become value destroyers with negative growth and low profitability. These businesses often require rights issues, rescue investments and dividend payouts will be cut.
Now, this is a generic model. Some companies manage to stay in certain zones for a very long time. Some companies never move from the speculative venture phase into a compound grower and end up straight in the value destroyer phase. But, this is a fairly useful model for thinking about companies.
Case Study - ASOS
First mover, but a lack of sustainable advantage.
ASOS PLC is a fast fashion provider in the UK. The share price one hundred bagged from its float in 2014. As the company came out of the speculative adventure phase, it had first mover advantage. But since then, it had a very volatile run and had fallen 95% from its peak.
First movers have counter-positioning in their industry, due to unique business models, and this can turn quite stunning returns on capital. But high profitability attracts competition, and those high profits will then often not be sustainable. We can see here that Asos's profitability was continually chipped down over time and eventually, the share price collapsed accordingly. In the following article, you will learn how businesses can maintain competitive advantage over their competitors.
This is the type of stock you likely want to avoid. You can, of course, make multiples on your starting investment if you buy well on the growth journey up in a share like ASOS PLC, but sustaining that position can be fraught with risk if the company does not earn an excess rate of return on capital. It's imperative to understand what happens in these businesses and how to identify those stocks that have a more sustainable advantage through time.
Extending Compound Growth
Good businesses stretch the period of compounding growth before it becomes a cash cow. If a company can create an "economic moat" around teh business, and tap into a large market size, it may be able to stretch out that growth phase for long periods of time. We have seen many extraordinary businesses in large global markets, such as Coca Cola or Disney or Microsoft, manage to extend their runway for very long periods of time. Other businesses do not have such extensively large markets, but a good enough runway is a critical part of the equation for potential multibaggers.
Simple, Scalable businesses
We found that multibaggers often benefit from quite stable industry environments. In our analysis of the top ten UK multi baggers, we found surprisingly that none were in the Technology or Biotechnology sector. In fact, the one in the healthcare sector that we did find was in the veterinary and pet care sector, CVS Group, not in pharmaceuticals.
We saw few disruptive technology stocks in the top ten multi baggers over a decade. Stable industries can be more conducive for long-term value creation than more volatile or disruptive industries.
Seven of the top ten multibaggers had very simple, scalable business models which served quite consistent needs. These included:
Omni-channel retailers, JD Sports and Games Workshop both run bricks and mortars retail operations, selling sportswear and games figurines respectively. They were able to have an actual real world presence, which they grew both in the UK and internationally as well as in online and trade channels. That is indicative of the kind of retail model many of the best companies deliver.
Location-based needs providers. CVS works in the pet and vet care market and Safestore in the storage market. Both of these businesses serve really persistent, stable and local needs.
Other simple, scalable business models: Jet2 (which started out being called Dart Group, until they divested to prioritise the leisure travel business), sell package holidays, encompassing the flights and accommodation in a very low-cost fashion. 4imprint sells branded promotional goods that small businesses need to market themselves. They did this from a single distribution centre in North America, and were able to scale up again and again through direct marketing to SMEs. YouGov had a unique network effect on its polling panels for brands and governments and other clients who need that data.
While they are a little more modern, many of these multibaggers served quite old-fashioned needs for their customer bases. That is an important insight here.
Specialist Markets
A couple of other companies from our top ten multibaggers that served specialist, niche markets were the Horizontal Acquirers in specialist markets, Judges Scientific and Renew Holdings.
Judges Scientific acquired very small companies that were so specialist in what they do in their scientific instruments that they really didn't have any competitors. They were able to acquire these businesses and drive good profitability from them. Fragmented niche markets are ripe to be aggregated by an acquisitive business model.
And similarly, Renew, in a very complex regulated market, were able to create vertical integration through acquisition of different companies. This is a way that businesses can carve out their own niche and become very profitable.
Finally, our outlier, Burford Capital, is a litigation finance specialist that has its own specialism in a niche market, which leads to potentially enormous fees from high-value commercial disputes and international arbitrations.
Niche or global markets? The impact of market size
Market size is a crucial consideration for businesses. Being a large fish in a small pond offers advantages like higher market share. While this might limit growth potential, it often means less competition, which can drive higher margins. Games Workshop demonstrates this effectively in the games and hobby products industry.
Conversely, large markets offer more organic growth opportunities. Though you might capture a smaller market share and face more competition, the margins can be more valuable due to scale. We see many large international companies maintaining high margins, primarily through branding and other competitive advantages we'll examine shortly.
What type of growth phase?
Ask yourself: are you investing for compounding growth or speculating on adventurous growth? Companies in the Speculative Venture phase carry a very high risk of failure, but can provide rapid share price gains. In contrast, more mature businesses may offer overlooked opportunities as they can compound growth at lower risk. All the businesses in our top ten were already profitable and paying dividends at the beginning of their multi-bagging journey.
‘Something New’ - the Multibagger Catalyst
Jim Slater knew what he was doing when it came to growth stocks, and wrote an entire chapter in the Zulu Principle on the idea of ‘Something New’. It may be the start of a new story, whether that's new management, new products or technology, new events in an industry. It could also be competitors going bust or new legislation or also new acquisitions. Spotting these moments in a company's trajectory can herald a new era in a business, a significant extension of growth, and significant share price returns.
Returning to our chart of a company’s lifecycle, when a company moves out of the Speculative Venture phase, they can extend their potential strength in the market by adding ‘something new’. JD Sports or Games Workshop have done so by launching new stores, regions or products on a consistent basis.
In 2007, Apple released the iPhone and has more than 60 bagged since. An even more impressive multibagger, Monster Beverage, which has a history dating back to the 1930s, shifted its focus to launch the now well known drink in 2002 and has more than 700 bagged since.
To recap, potential multibaggers typically feature:
simple business models with consistent operations
often introduce "something new" that catalyzes their extraordinary growth.
Don't dismiss companies for seeming mundane—these overlooked businesses often harbour the greatest multibagging potential. Stay alert for those catalytic changes that can transform ordinary companies into exceptional performers.
In our next article, we'll explain the important concept of economic moats and how to identify whether a potential multibagger can sustain its competitive advantage over the long term!