The Art of Sitting through big winning stocks

Multi-baggers are the dream of any investor, and equity market is the best avenue to realise that dream. The flexibility to move capital from one stock to another with minimal transaction costs makes equities stand out from other asset classes, when it comes to exploiting the best opportunities in an ever -changing economy.

On equities, what concerns most investors is its inherent volatility. This issue props up due to the readily-available prices of stocks, which quickly adjust to any market or stock-related news. In contrast, an asset class like real estate, where the prices are not readily observable, gives investors the comfort to stay invested for the long term.

Given that earnings is the driver of stock prices in the long term, it is only natural that stocks which have more predictable sales and earnings tend to display less volatility. Such stocks can give you the conviction and peace of mind to stay invested for longer, so that stock prices can compound to turn into multi-bagger gains. Further, to make your gains in a shorter period of time, earnings have to grow at a faster clip as well.

This calls for investing in companies which are run by competent managements and have the right products for the marketplace. Such companies have what it takes to grow their sales and earnings even when conditions in the economy are not conducive for growth. Examples of such companies include the likes of HDFC Bank and Eicher Motors, among others.

Take the example of HDFC Bank. The bank started in 1994 after Reserve Bank of India (RBI) started issuing bank licenses to new entrants in the private sector. In its early days, the bank could not compete with the public-sector banking giants in the corporate lending business due to the lack of its deposit base. The business acumen of the bank’s top management to exploit the inefficiencies in the money clearing system among the stock market participants, gave the bank a dominant share of the clearing business. Instances like this signal a company is run by competent leaders, which bodes well for the stock.

Look at Eicher Motors, which had many businesses under its hold at the dawn of the century. Its business portfolio comprised Royal Enfield motorcycles, commercial vehicles, tractors, and gears. Later, the management decided to retain the motorcycles and commercial-vehicle businesses, and dispose of the other segments, as the management realized that it needed to give more attention to the individual businesses. Over the years, Royal Enfield has become the driver of the Company’s sales and earnings growth. Clearly, the company had the right product for the market, with minimal competition in its class. And the management’s decision to focus on limited number of business segments has reaped dividends for the company and its shareholders.

Now, how does one identify such multi-bagger stocks early in their price run? Research over the years has shown that most such stocks began their price run after showing at least one or two quarters of sizeable sale and earnings growth. It would be better for investors to wait for at least two quarters of earnings growth in excess of 25% on a year-on-year basis, to make sure that the growth is not a one-off affair. Further, the earnings growth has to be accompanied by sales growth as well, since no company can grow its earnings sustainably over the long run by just cutting down on its costs.

Stocks which exhibit such features of a true winner will stand out on stock charts as well. By the time, the market becomes cognizant of a stock’s prospects; accumulation – buying on heavy volumes – can be seen on the chart, resulting in the formation of base patterns such as cup-with-handle and flat base among others. Combining both fundamental and technical analyses, keep a stock on your radar when it has delivered at least two consecutive quarters of year-on-year EPS growth of 25% or more. Make the plunge when it breaks out a base pattern on high volume.

Once you have bought such “performing” stocks, hold the stock as long as it delivers good sales and earnings growth, combined with healthy buying on the stock chart. The time for selling comes when either the stock gives two consecutive quarters of poor sales and earnings growth; or distribution in the form of heavy selling becomes visible on the stock chart.

GAUGE THROUGH MULTI-BAGGERS

• Big stocks begin their price run after showing at least one or two quarters of sizeable sale and earnings growth
   
• On equities, what concerns most investors is volatility due to readily-available prices of stocks
   
• To make your gains in a shorter period of time, earnings have to grow at a faster clip as well
   
• Earnings growth has to be accompanied by sales growth as no company can grow just by cost cutting
   
• Real estate where prices are not readily observable gives investors the comfort to stay long term

The writer is CEO, MarketSmith India