That would turn an initial $10,000 investment into $1,000,000. It’s safe to say the book had my undivided attention!
The reader is guided through a number of stories of ordinary people who have managed this seemingly extraordinary feat before diving into more detailed case studies of a few of the companies behind stories like these, including those of Monster Beverage, Amazon, Pepsi and Gillette.
So how do we do it? The greatest chance of success comes by identifying companies that earn high and lasting returns on equity (ROEs). This is a measure of the return a company generates on the equity invested in the business. If you invested $100 to start your own business and earned $25 in your first year, your ROE would be 25 per cent. If the company is able to deliver a high and lasting ROE then once the profits are reinvested, that’s when you start to benefit from the miracle of compounding, and that’s when you have something really special on your hands.
Another common factor the author identifies is having an owner-operator with plenty of skin in the game. The basic principle is that people with their own wealth at risk make better decision than those who are hired guns. The reason is they are fully aligned with shareholders, their focus is on building long-term value rather than focusing on bonuses or stock options for hitting short-term targets.
The author then touches on what in my view is the most crucial mistake investors make, being that once you own one of these companies, either through luck or skill, the key is making sure you don’t sell them too early! The lesson is that these investments aren’t going to go up in a straight line, filter out the noise and focus on the fundamentals.
The essential principles of finding 100 baggers are summarised as follows:
- You have to look for them. Don’t waste your time looking for stocks that may rise by 30 or 50 per cent; focus on finding those 100 baggers.
- Growth, growth and more growth. This is a critical point; you want to find companies that have lots of room to grow into.
- A low valuation multiple. You need to combine this earnings growth with a low valuation multiple that can expand.
- An economic moat. This is the defendable competitive advantage that means the company can continue to generate high returns and reinvest these at high rates for many years.
- Smaller companies are preferred. Start with acorns, wind up with oak trees. Start with oak trees and you won’t have the same dramatic growth.
- Owner-operators are preferred.
- Time. Most of the 100 baggers in the study took 20-25 years to get there.
- A good noise filter. Focus on the fundamentals and don’t get distracted by the short term.
- Luck helps!
The book ends with the fact that there is no magic formula for finding 100-baggers. While this sort of conclusion to investment books is all too familiar, the book certainly highlights the key ingredients to success and proves an interesting read. For me, however, it was the long list of 100-bagger stocks at the end that made me want to get out there and start searching for the next ones!
The JM Finn Investment Book Club was convened in the hope that month by month, some of the wisdom of investing gurus such as Warren Buffet, Charlie Munger, and Mohnish Pabrai might rub off on the participants eager selves.