Five traits to make a multi-bagger

When Peter Lynch first coined the term ‘multi-bagger’ he referred to companies whose share price had risen more than 100%, thus doubling shareholders’ original investment. A two-fold return is a wonderful outcome (especially in today’s markets) but when private investors hunt for multi-baggers, most of them are not really looking to just double their money. They’re after something much bigger.

But forgetting the origins of the term multi-bagger and the style of investing behind it is a mistake made by many inexperienced investors. Lynch didn’t hunt high risk, high-flying stocks, he was after quality - the type of quality that can be reinvested to spur impressive earnings growth over the medium to long term.

In the many studies that have attempted to capture the metrics that make a multi-bagger, high-quality profits always make an appearance. Sensible valuations are also surprisingly frequent, as companies which hit multi-bagger status tend to do so thanks in part to multiple expansion. Put plainly, that means their price to earnings multiples (or other valuation ratios) get higher, and in order to do so, those multiples can’t be too high to begin with. These are valuable lessons for investors hunting for the multi-baggers of the future.

So, while looking back at the multi-baggers you may have missed can be frustrating, there are lessons to be learned in the past performance of stocks. This article will run through five of the biggest winners for UK private investors in recent years and attempt to identify five of the shared qualities that you can use in the hunt for your next multi-bagger.

1. Domino’s Pizza: The might of a franchise

It is testament to the strength of the Domino’s brand (which encompasses its easily-distinguishable pizzas), that in 2023 the company still occupies a niche in the pizza delivery industry. Last year, the UK’s takeaway food market was worth £21.4bn, of which pizza delivery accounted for £3.7bn.

That’s a far cry from the £304m market which Domino’s dominated when it listed on AIM in late 1999. Then, Domino’s estimated it had a market share of 65% and, with its newly launched online delivery service (the first company in the UK to offer takeaway food online), management was predicting to take even more market share in the coming years.

They were right. In the five years following the IPO, sales rose at a compound annual rate of 33%. And with more success came more demand from new franchisees. In 2005, while management at the company focused on developing the brand, many applications were made to the franchise. That year the company opened 50 new stores.

The franchise model also supported very strong profits and cash inflows. And after investing heavily in the operating system the company chose to return that cash to shareholders via dividends and buybacks. Between 2005 and 2010 the company returned £83.8m of cash to shareholders.

2. Bioventix: A picks and shovels strategy

I first visited Bioventix at the offices/factory/research hub in Farnham in 2015. I had just finished my dissertation on the role of specific immune cells in response to exercise and was interested in the role of antibodies in detecting disease.

Like many small cap biopharma operations in the UK, Bioventix was not well covered by analysts or the financial media (not many financial journalists have a background in immunology), but the story had been picked up by the private investor community thanks in part to the comparisons that were being made with Abcam (the antibody specialist which was one of AIM’s top performers before it moved its listing to the US). Like Abcam, Bioventix provides antibodies to the global biopharma industry, specifically for use in diagnostics machines.

The diagnostics industry is dominated by massive companies like Beckman Coulter and Siemens, whose machines rely on antibodies to detect disease from blood (or other) samples. Most antibodies that are used in these machines come from rabbits, but Bioventix had created a process which uses sheep antibodies, which can detect disease with higher efficacy.

The science behind the company is not easy to understand, but the numbers are. Bioventix operating margins are astonishing - averaging close to 80% over the past decade. And having established itself as a reliable provider of crucial antibodies, the company has built up a roster of repeat customers.

Just like the investors who bought picks and shovels during Australia’s gold rush, Bioventix investors have benefited from a surge in demand for diagnostics.

3. Fevertree: The power of the brand

Tim Warrillow and Charles Rolls brought Fevertree to AIM after an intensive period of research (travel) in Africa and the Mediterranean in the hunt for the perfect tonic. It was a necessary trip - after all, “if three quarters of your gin and tonic is the tonic, make sure you use the best.”

From the logo to the bottle, Fevertree’s tonic looks premium and, more importantly, it tastes premium, which keeps customers buying - especially in the company’s early days when premium tonic was a novel idea and it was one of the only companies in the market.

But the key to Fevertree’s early success was its marketing, which many investors (and even its competitors) overlooked. Soon after its launch, the company put together a campaign in which it delivered gin and tonic menus (which all used one of Fevertree’s own tonic flavours) to premium drinking establishments. Between 2014 (when the company joined the market) and 2019 (just before the pandemic put paid to the following year’s growth ambitions), sales rose at a compound annual rate of 50%.

Just like another very successful soft drinks brand before it (Coca-Cola), Fevertree outsourced its bottling to other companies, which helped support high operating margins. The company’s expenditure has mainly been in marketing and new product development to keep up the pace of growth. Growth which helped justify exorbitant valuation multiples.

4. Games Workshop: Niche audience, mainstream share

Games Workshop’s miniature figures have been popular among gamers since the company founded in 1975. The collectible figures all form part of the Warhammer fantasy world and players have long enjoyed the community spirit that has been nurtured by the Games Workshop high street shops. A nice company in a niche space, but nothing special to say about the shares.

Until 2015 when Kevin Rountree came to the helm as chief executive. He oversaw a revamp of the group’s core game and a social media strategy which helped the community thrive online. With an online presence he was able to take the brand overseas and began licensing the intellectual property to bring in a new, highly profitable, revenue stream. The Warhammer brand is now featured in many video games for PC, console and mobile, and the company is currently in talks with Amazon Studios.

Rountree also oversaw a streamlining of the group’s store offering to cut down costs and enhance profits. Many of the stores became ‘one person’ stores, managed by a single, highly engaged member of staff. Operating profits have risen from 15% in 2015 (when Rountree became CEO) to 38% last year.

And as the business continues to throw off cash, the management team has maintained its discipline with spending plans. The primary purpose of the cash generation is to maintain a healthy balance sheet - one that has not relied on any borrowing or fundraising for over a decade. Secondly, the cash is used to maintain the current high standard of operations. And then it’s reinvested into the business for growth plans. Any “truly surplus” cash is then paid back to the shareholders as dividends - Games Workshop has not missed a dividend payment in all of Rountree’s tenure.

5. Apple: Some elephants can gallop

In 2012, Apple was the biggest company in the world. Its share price had risen almost a third on the previous year and its market capitalisation was approaching half a trillion dollars. That year the company sold 125m iPhones - more than it had ever done before. It had laptops and the iPod and sold a bit of music through its iTunes services business. Its logo topped the roster for the world’s most recognisable brands.

To become a multi-bagger at this point, the company would have to hit a $1trn valuation. It would require a material uptick in sales in what appeared to be a largely saturated market - surely not possible?

But fortunately for Apple an internet revolution was happening. Facebook and Twitter were gathering an army of followers who increasingly required instant gratification for their social media addiction. Meanwhile the telecoms companies were launching increasingly advanced mobile networks which allowed more complex data to be sent between cell phones. By 2015, the number of iPhone sold in a year had almost doubled to 231m.

Meanwhile, Apple continued to build its walled garden of products, enticing customers to buy more iPhone compatible gadgets. When the company removed iPhone’s earphone doc it provided a handy alternative: AirPods, which currently retail at £179 (about the same price as the original iPhone). And then there was the watch, first launched in 2013 which sold 60m devices last year.

And even more significant than all the gadgets has been Apple’s dominance of the app sales space - what it calls its services division. Every time an iPhone user (one of the 1.8bn worldwide) makes a purchase in the app store, Apple takes a cut. That, plus the expenditure on its cloud data storage space generated $21bn at an operating margin of 71%.

What makes a multi-bagger?

Looking at these five examples, it’s clear that there is no one set recipe for a multi-bagger. All five operate in different industries, have different business models and customers, and have peaked during different points of a market cycle. Lesson one, therefore is to keep an open mind in the hunt for your next multi-bagger - there is no one rule for the type of stock which can achieve this status.

It is however worth noting that four of the five examples above are consumer-facing companies. This reflects the findings of a 2020 study by US asset management group Alta Fox which identified 15 UK multi-baggers between 2015 and 2020, nine of which were consumer facing. That said, globally, the technology and healthcare industries have proved the most fruitful hunting ground for multi-baggers in the past, accounting for more than 50% of the growth stocks identified by Alta Fox.

So if there is no one industry (or no one geography) that helps identify multi-baggers, what lessons can we learn from the past?

We have identified five traits in these five companies:

1. High profitability
2. A protective business moat
3. Operating in growing industries
4. Scope for multiple expansion
5. Engaged and experienced management

Let’s look at these in more detail.

First is that these stocks were all highly profitable before their shares began to climb. Strong operating margins (which can be an indicator of a high operating leverage) and a decent return on capital employed are both widely observed in stocks before they become multi-baggers. That isn’t to say that unprofitable companies can’t generate extraordinary returns for their shareholders, but picking these stocks requires a different mindset. How many investors can sleep easily at night knowing they are holding high risk, unprofitable companies? With reliably profitable companies, investors can have the confidence to hang on and let compounding do its work.

Second, they all had a protective business moat which gave them a competitive advantage over peers in the market. Business moats can come in the form of brands, intellectual property or a tight network of customers. This moat is essential both as the business is growing and for it to retain its place in the market. Growth companies which lose their protective moat (like Asos) can quickly become miserable shares to own.

Third, all the stocks in the example above operated in growing industries. In some cases these were new industries formed from a market shift - Domino’s selling pizzas online, for example, or Apple and the rise of the internet bringing with it the proliferation of the smartphone. In other cases, it was the companies themselves which formed a new growth market in a stagnant existing one - Fevertree with its ‘premium mixers’, for examples.

Fourth, is a valuation multiple with room for expansion. In all of the cases highlighted above, the stock’s PE ratio rose throughout its growth phase, normally from a low starting point. Even Fevertree (which started with a lofty price to earnings ratio) managed to deliver multiple expansion between 2014 and 2019.

And finally, an engaged management team. I have never held shares in any of the companies mentioned above (except Apple), but in each case I know who the chief executive is. For all five companies he (they have all been run by men through their growth phase) has made himself known to private investors, delivering useful presentations and keeping shareholders informed of his investment decisions. And those investment decisions (whether that be in product development, marketing or dividends) has been sensible and profitable.