Do global multi-baggers continue to outperform?

I recently wrote an article as a follow-up to the popular multi-bagger studies, looking at the subsequent performance of the UK multi-baggers. To do this, I used two studies: "The makings of a multi-bagger" by hedge fund Alta Fox in 2020 and, more recently, Stockopedia's 2023 study, which looked at the best-performing UK Stocks over the previous decade.

The key attributes of stocks that generate exceptional performance found by these studies (and others) tend to be the same. I have previously summarised these into my "MROC" framework. Investors should be looking for companies that have moat, runway, operational leverage and are cheap.

Moat

These are companies with a sustainable competitive advantage. This means that competitors have been unable to deploy additional capital to eat into their returns over time. Instead, the company can reinvest capital at high rates to drive sales growth.

Runway

A moat is a great asset for a company, but if there isn't scope to deploy additional capital at very high returns, the business will always remain niche. For investors to receive phenomenal returns, a company requires a significant growth runway ahead.

Operational Leverage

A strong moat and significant sales growth alone can generate excellent profit growth, which may be reflected in the share price. However, the returns will be even higher if the bottom line grows faster than the top line. This is known as operational leverage.

Cheap

The best returns came from investing in companies where sales grew quickly, profits snowballed, and the multiple the market gave those earnings expanded. Multiple expansion is far more likely when investors pay a low multiple when purchasing a stock.

If these qualities are present in great companies and missing in the rest, then investing in great companies should keep generating strong returns. However, when I looked at the subsequent performance of the previous UK high-performance stocks, the results were a bit deflating. Far from being a secret of success, investing in all previously high-return stocks was a losing strategy and significantly underperformed wider market indices. In particular, the UK companies in the Alta Fox study had subsequently underperformed the UK Allshare index by around 50%.

I did manage to improve the future results of the multi-baggers from the Stockopedia study by excluding loss-making shares and those that had grown sales or share count very rapidly. However, it only improved the results to the market average rather than something more impressive.

This leads to a strange contradiction – in order to have a stock that generates an exceptional return, it must first have been a 2-bagger, 5-bagger, 10-bagger, etc. Yet the place to look for the most likely 5-bagger isn't amongst the recent 2-baggers, and 5-baggers are more likely to give up their gains than become a 10-bagger. This doesn't mean that the MROC framework is worthless. It is an excellent way of finding stocks with the potential to multi-bag. It is just that other factors appear also to be driving high returns, such as investor sentiment, and these are far more likely to mean revert than continue to drive high returns.

When I did my initial analysis, I only looked at the UK stocks because these companies are stocks that the average UK investor would have heard of. However, the UK market has been a bit of a global laggard lately. Perhaps my results were due to the quirk of fate that has made the UK a relatively poor-performing market. Maybe multi-baggers in other countries fared much better. In particular, many investors feel that the recent strong performance of the US market makes it a much better hunting ground for high-return stocks. But is this true?

The Data

Thankfully, the Alta Fox study was a global study of the best-performing stocks domiciled in North America, Western Europe, and Australia (excluding energy, materials, and financials), so I have the data to answer this question. Of the 104 stocks that delivered greater than a 350% return in the five years, this is the country breakdown:

Here is the return of these stocks in the Alta Fox study by country:

However, this is the average return of these stocks after the initial study ended on 8^th June 2020 through to 20^th September 2024:

Far from being an outlier, the UK performance is fairly typical of these types of stocks. Indeed, the US stocks faced a similar loss, on average. Only Australia and Sweden were in positive territory. This performance is even worse when we look at the returns compared to the indices for each country:

In this case, only Sweden generated a significantly positive subsequent relative return.

[Note that I have simply taken the index return from the absolute return, so this can go below -100%. This doesn't mean that investors have lost all their money. For example, Canadian index investors received a 61% price return from June 2020 to September 2024. Those who held the past Canadian multi-baggers from the end of the study lost 61%. Index investors ended up with four times the amount of money in the end!]

Taking the weighted average across all these stocks, they generated a 12% return in the subsequent period. However, the weighted average of the indices generated a 62% return, giving a 50% relative underperformance for the whole set of stocks. The broader conclusion matches that of the UK-only analysis: past multi-baggers are more likely to underperform than continue to generate those great returns.

What made the difference?

When I analysed the Stockopedia UK multi-bagger data, I found that extreme returns led by exceptional revenue growth tended to mean revert. The same effect can be seen here in the global data. The very high return stocks in the Alta Fox study are some of the worst performers subsequently:

Notably, in the top 20 highest-performing stocks in the Alta Fox study, three were total losses; two went bankrupt, and one turned out to be a fraud. I call these Icarus stocks—they flew too close to the sun! While the relationship here is clearly negative, it is also noisy. Even some more modest-performing stocks suffered a total loss, or close to it.

As a value investor, I'd love to think that the high earnings multiples led to many companies' downfall, with investors getting carried away with the potential for future growth. There is some evidence for this at the country level. Sweden is a notable outlier here, though:

At the individual company level, the pattern is less clear, and multiple mean reversion can't be the only explanation:

It is worth noting that all three loss-making stocks (that hence don't feature on this chart) were significant losers. It seems avoiding loss-making stocks is a good strategy, no matter how good past returns have been.

These companies are not just experiencing mean reversion in sentiment. The biggest driver of their poor average returns is the mean reversion of the business performance itself.

What about Sweden?

Sweden is the outlier here, with high-performing stocks that have kept going. While the subsequent returns are not as good as the initial study returns, these have shown significant outperformance. Perhaps this is a market that UK investors should consider more seriously in their search for high-performing stocks. What I noticed while looking through the Swedish companies in the Alta Fox study is that they tend to be fairly mundane. For example, they do software for accountants, consumables for life sciences, medical equipment, logistics, or cabling and accessories. This leads us to another contradiction in our search for multi-baggers. When looking for exciting returns, a boring business is usually best.