Multi-baggers are as fickle as the markets

Multi-baggers are as fickle as the markets

Compounders will always turn out to be multi-baggers, but the reverse is not a workable assumption. Here's why

After an investment phase comparable to a dream run, the markets are gradually settling down. The occasional bouts of fear and the regular capitulation seen in overvalued companies only keeps the excitement quotient alive. Even though most serious investors clearly realise that the party of 2017-18 is drawing to a close, few people have left the party. Nobody wants to be left out of any residual excitement.

Investment performance over a shorter period looks ordinary. Red ink has started to mark mid-cap portfolios. An uneasy calm prevails over mid-caps, which have seen the most stellar investment performance in our market's history. The question on everybody's mind is when the trend will regain its mojo and create a resurgence in fallen stocks. To answer that, we should understand the genesis of the recent investment performance by mid-cap stocks that had stayed static for years and suddenly saw markets aggressively rerating them. The market perception altered dramatically over just a few quarters leading to a drastic gain in the stock prices of these companies. The one-way rise led to their being adjudged compounders. But the context in which they showed outlier performance in business and in the stock markets was hardly going to remain static for long. The line between multi-baggers and compounders got blurred.



What do we mean by this? Compounders tend to grow their business performance and valuations over extended periods of time. Their rise is never sudden. They gain credibility after years of consistent business growth and develop an investor following that is stable, reliable, and unshakeable. Even when investors develop short spells of doubt around these, they quickly stabilise to re-establish their reliability. Stocks that are long-term compounders turn out to be multi-baggers in the long run. But stocks that turn out to be short-term multi-baggers need not necessarily become long-term compounders.



The context under which multi-bagging happened needs to sustain if the stocks must keep compounding. Outlier stocks from one bull run rarely sustain their performance after markets cool down. The circumstances in which they became multi-baggers often change quickly and they rarely reach their glory days for long periods.



Every bull market throws up multi-baggers from several emerging stocks. Most such multi-baggers make their greatest returns within a short time. The stock price appreciation is mostly backloaded and the rise is usually abrupt. Bull markets see several stocks subscribe to this pattern. Typically, around every market peak, several stocks grow manifold quickly. Often, these gains take place within a period of just a year. The past year saw several stocks perform brilliantly making them multi-baggers, and investors who owned them gained iconic status.



Naturally, this created a euphoric surge in the investor community comparable to a gold rush. Everybody craved to own the next multi-bagger. And thus, began the virtuous search for the next multi-bagger. Stocks that an influential section of the market felt were potential multi-baggers got lapped up quickly. Institutions hurried to deploy capital and this sense of urgency added fuel to the multi-bagger hunt. Savvy institutional brokers and early investors created and managed scarcity of stocks in these companies. Sellers froze seeing money chase these stocks. That was the perfect setting for a virtuous rise.



Multi-baggers were easy to create. All that was needed was a few quarters of superior earnings. These earnings were supported by changing commodity prices, falling interest costs, rising demand in specific product niches, and widening margins. The float in these stocks dried out quickly and prices went up one way. For a brief while, these multi-baggers were mistaken to be compounders. It seemed the profits would keep growing. Then suddenly, the very pattern that created the earnings expansion, reversed. Commodity prices shot up, interest rates started to rise, exchange rates rose, and demand softened. The markets began to develop self-doubt. The conviction simply could not be supported by fundamentals. This led to a swift unwinding in valuations of multi-baggers. Clearly, investors who failed to see this coming were caught on the wrong foot. This magnified the panic in these multi-bagger stocks. The inevitable recoil in stock prices was accelerated by governance concerns and rumours.



The lesson from this market boom is simple. Multi-baggers are often products of business circumstances, competitive context, and scarcity of shares. All three can change swiftly. Investment momentum always thrives and grows in such circumstances. But compounding is a sustained activity where circumstance and context remain stable for extended periods of time. The market position of these companies remains strong, lending business performance across economic cycles. Compounders will always turn out to be multi-baggers, but the reverse is not a workable assumption.




Happy Investing
Source:Valueresearchonline.com