Mental Models discussed in this podcast:
- Operating Leverage
- Davis Double Play
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Show Outline
How to identify 10-bagger investments
- A 10-bagger investment: We’re going to focus on how to 10x your money over a 10-year time period. I’ll discuss examples and what to look for in an investment in order to identify these types of opportunities.
- This represents a 25.8% annualized rate of return. (Massively exceeding the average 10% return in the stock market.)
Example 1: “Davis Double Play”
- Grow an investment from $10 per share to $100 per share.
- If done over a period of 10 years we know this is a >25% rate of return.
- Starting EPS: $1, doubles every 5 years, so it ends at $4 per share.
- Starting buy price: $10 per share (P/E of 10.)
- Sell price: $100 per share (P/E of 25) – Find companies capable of becoming overvalued
- Earnings growth rate: 14.8% per year
- Multiple expansion contribution: 9.6% per year
Example 2: Deep Value
- Starting EPS: $2.50 per share
- Ending EPS: $5.00 per share (7% growth rate)
- Starting price: $10 per share (P/E of 4)
- Ending Price: $100 per share (P/E of 20) (17% contribution from multiple expansion)
Example 3: Hypergrowth
- A very simple example
- Starting EPS: $0.50 per share
- Ending EPS: $5 per share (25% EPS growth rate)
- Starting price: $10 per share (P/E of 20)
- Ending price: $100 per share (P/E of 20) (0% contribution)
Key Characteristics of 10-bagger potential stocks
- Low Price (Ideally target companies with a P/E multiple less than 10)
- Operating leverage (Should be able to grow earnings faster than revenue)
- Turnarounds (Flipping from unprofitable or breakeven to profitable can lead to large earnings growth AND multiple expansion)
- Microcaps and Nano caps (Smaller companies are more likely to benefit because they may be more overlooked)
- Growth is critical to a 10-year ten bagger
Summary:
My preferred method of identifying potential 10-bagger stocks is to seek Davis Double Play type investments. I want cheap stocks with the potential to become overvalued.
In order for an investment to become a 10-bagger and earn 10x your money in 10 years it needs to have certain traits: Low price, operating leverage, turnaround situation, overlooked company, and earnings growth.
References
