76 - How to identify 10-bagger investments (10x in 10 years)

Mental Models discussed in this podcast:

• Operating Leverage
• Davis Double Play

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Show Outline

The full show notes for this episode are available at https://www.diyinvesting.org/Episode76

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

• Focused Compounding Note on Davis Double Play