100 Baggers: Stocks That Return 100-To-1 and How to Find Them

by Christopher W. Mayer

Phelps advises looking for new methods, new materials and new products—things that improve life, that solve problems and allow us to do things better, faster and cheaper.

“One of the basic rules of investing is never, if you can help it, take an investment action for a noninvestment reason,” Phelps advised. Don’t sell just because the price moved up or down, or because you need to realize a capital gain to offset a loss. You should sell rarely, and only when it is clear you made an error.

The biggest hurdle to making 100 times your money in a stock—or even just tripling it—may be the ability to stomach the ups and downs and hold on.

He looked at 19 such 100-baggers. He drew four conclusions, which I excerpt below: The most powerful stock moves tended to be during extended periods of growing earnings accompanied by an expansion of the P/E ratio. These periods of P/E expansion often seem to coincide with periods of accelerating earnings growth. Some of the most attractive opportunities occur in beaten-down, forgotten stocks, which perhaps after years of losses are returning to profitability. During such periods of rapid share price appreciation, stock prices can reach lofty P/E ratios. This shouldn’t necessarily deter one from continuing to hold the stock.

Here are a few attributes I’ve chosen from Maloney’s more extensive list: Stock traded for two times forward earnings (cheap!). Business was a cash cow with 70 percent gross margins. Long runway—MTY was just a tiny fraction of the fast-food industry.

So, taking those profits and reinvesting them created a flywheel of rapidly growing revenues and earnings.

I call these two factors—growth in earnings and a higher multiple on those earnings—the “twin engines” of 100-baggers. We will come to this point again.

As the chart shows, a 21 percent annual return gets you there in about 25 years. (That’s about the average 100-bagger in my study.) But there are other ingredients as well. “Our analysis of the 100x stocks suggests that their essence lies in the alchemy of five elements forming the acronym SQGLP,” they wrote: S—Size is small. Q—Quality is high for both business and management. G—Growth in earnings is high. L—Longevity in both Q and G P—Price is favorable for good returns. Most of these are fairly objective, save for assessing management. “In the ultimate analysis, it is the management alone which is the 100x alchemist,” they concluded. “And it is to those who have mastered the art of evaluating the alchemist that the stock market rewards with gold.”

To make money in stocks you must have “the vision to see them, the courage to buy them and the patience to hold them.” According to Phelps, “patience is the rarest of the three.”

many of his chosen stocks had top-management teams that made good capital decisions about how to invest company resources. There was often a large shareholder or an entrepreneurial founder involved. These can overcome the growth hurdle.

It takes vision and imagination and a forward-looking view into what a business can achieve and how big it can get. Investing is a reductionist art, and he who can boil things down to the essential wins.

“The biggest point to convey,” Thompson wraps up, “is that return on capital is extremely important. If a company can continue to reinvest at high rates of return, the stock (and earnings) compound … getting you that parabolic effect.”

Netting a 100-bagger takes vision and tenacity and, often, a conviction in an idea that may not yet be obvious in the financials.

First, it’s important to think about what a company can earn on the money it invests. When a company can build book value per share over time at a high clip, that means it has the power to invest at high rates of return.

Those stocks that are most attractive on a net-present-value basis are the ones that can grow at a high rate. And to grow at an above-average rate, they have to have some kind of sustainable competitive advantage. These stocks generate high ROEs.

Jason starts his process by screening the market, looking for high-ROE stocks. “If a company has a high ROE for four or five years in a row—and earned it not with leverage but from high profit margins—that’s a great place to start,” he said. But ROE alone does not suffice. Jason looks for another key element that mixes well for creating multibaggers. “The second piece requires some feel and judgment. It is the capital allocation skills of the management team,”

I asked about stock buybacks, which boost ROE. He’s agnostic, generally. But he’s leery of buybacks and no sales growth. “If you have a company with tons of cash flow but top-line [sales] growth is 5% or less, the stock doesn’t go anywhere,” he said. “IBM is a good example. Good ROE. Cheap. But the absence of top-line growth means the decline in share count has been offset by multiple contraction.” As a result, the stock goes nowhere. Jason is reluctant to buy a high-ROE company where the top line isn’t at least 10 percent. But when he finds a good one, he bets big.

The guys who make consistently good decisions tend to be owners with skin in the game. They also tend not to take bet-the-company risks. “The smart entrepreneurs don’t actually go for home runs,” Jason said. “They hit a ton of singles.”

To sum up: It’s important to have a company that can reinvest its profits at a high rate (20 percent or better). ROE is a good starting point and decent proxy. I wouldn’t be a slave to it or any number, but the concept is important. You want to think about return on capital in some way—the higher, the better. You want to think about what a business can earn on the money invested in it and its ability to reinvest cash at that rate—the longer, the better. The road to 100-baggerdom is much, much harder otherwise.

“Owner-operators, over an extended period of time,” Doyle said, “tend to outpace the broad stock market by a wide margin.”

What’s also interesting about these owner-operators is they are underrepresented in the S&P 500 index—a widely quoted index meant to stand for the market as a whole. As Matt pointed out, the S&P 500 uses a float-adjusted market cap to determine the weight in the index—meaning, the S&P counts only what is not in the hands of insiders. “It’s the free-float market cap,” Matt explained. “So if somebody like Warren Buffett were buying more Berkshire Hathaway, the weighting in the S&P 500 would go down. It’s precisely counter to what you would want to happen. If the person running the business were buying more stock, then you want the weight to go up, if anything. The S&P is doing precisely the opposite, which is ridiculous.”

One of them is that the rich have access to networks—through social and business connections—that give them better information. It helps them keep their edge over less connected peers.

The main idea is that these CEOs were all great capital allocators, or great investors. Capital allocation equals investment. And CEOs have five basic options, says Thorndike: invest in existing operations, acquire other businesses, pay dividends, pay down debt or buy back stock. (I suppose a sixth option is just sitting on the cash, but that only defers the decision of what to do with it.) They also have three ways to raise money: issue stock, issue debt or tap the cash flow of the business. “Think of these options collectively as a tool kit,” Thorndike writes. “Over the long term, returns for shareholders will be determined largely by the decisions the CEO makes in choosing which tools to use.”

each understood that capital allocation is the CEO’s most important job; value per share is what counts, not overall size or growth; cash flow, not earnings, determines value; decentralized organizations release entrepreneurial energies; independent thinking is essential to long-term success; sometimes the best opportunity is holding your own stock; and patience is a virtue with acquisitions, as is occasional boldness.

Everybody knows this part of the story: Buffett invested the float. What people may not know is just how cheap that source of funds was over time. To put it in a thimble: Buffett consistently borrowed money at rates lower than even the US government. How is that possible? If premiums exceed claims, then Buffett effectively borrowed money at a negative rate of interest. He took in premiums. He invested the money. He kept all the profits. And when he repaid the money (by paying claims), he often paid back less than he borrowed. From 1965, according to one study, Berkshire had a negative cost of borrowing in 29 out of 47 years. Chirkova cites another study that puts Berkshire’s cost of borrowing at an average of 2.2 percent—about three points lower than the yield on Treasury bills over the same period. This is the key to Berkshire’s success. It’s hard not to do well when nearly 40 percent of your capital is almost free.

good holding companies are business builders. He notes that wealth creation—real wealth creation, “not flying-first-class wealth, but having-libraries-named-after-you kind of wealth”— comes from owning and operating and building businesses and having a long-term commitment. “And that’s what I see in the Brookfields, the Loews and the Leucadias.”

Todd looks to buy holding companies at a discount to the sum of their parts’ value. He also looks for high insider ownership and an owner-operator structure. He prefers fortress balance sheets and low debt levels. These are just a few of the many traits Todd looks for.

when you have a good thing, you bet big.

I favor the half-Kelly because it cuts the volatility drastically without sacrificing much return. Poundstone says a 10 percent return using full Kellys turns into 7.5 percent with half-Kellys. But note this: “The full-Kelly bettor stands a one-third chance of halving her bankroll before she doubles it. The half-Kelly better [sic] has only a one-ninth chance of losing half her money before doubling it.”

Keep the list of names relatively short. And focus on the best ideas. When you hit that 100-bagger, you want it to matter.

A buyback is when a company buys back its own stock. As a company buys back shares, its future earnings, dividends and assets concentrate in the hands of an ever-shrinking shareholder base.

“It’s common sense to pay more for something that is more durable. From kitchen appliances to cars to houses, items that last longer are typically able to command higher prices. … The same concept applies in the stock market.” Companies that are more durable are more valuable. And moats make companies durable by keeping competitors out.

Berry made an interesting point here about the size of the firm relative to the market: “Imagine a market where the fixed costs are high, and prices are low. Imagine that prices are so low that you need 55% of the market just to break even. How many competitors will that market support? One. Not two, not three … one.” The firm that gets that 55 percent is in a commanding position. It can keep prices just high enough that it can keep others out and earn a good return. “What matters is the amount of the market you need to capture to make it hard for others to compete,” Berry points out.

You have surely heard the quip from Warren Buffett that “when management with the reputation for brilliance meets a company with a reputation for bad economics, it’s the reputation of the company that remains intact.” Remember it, because it’s true.

The central observation is that even the best industries include companies that destroy value and the worst industries have companies that create value. That some companies buck the economics of their industry provides insight into the potential sources of economic performance. Industry is not destiny. This is useful to know because some investors will avoid industries entirely—like airlines—that have been bad for investors. But there are many ways to make money within the airline industry.

What Mauboussin aims to do is show where the profit in an industry winds up. These profit pools can guide you on where you might focus your energies. For example, aircraft lessors make good returns; travel agents and freight forwarders make even-better returns. Mauboussin’s industry analysis also shows that industry stability is another factor in determining the durability of a moat. “Generally speaking,” he writes, “stable industries are more conducive to sustainable value creation. Unstable industries present substantial competitive challenges and opportunities.”

Research by Credit Suisse HOLT® shows that less than 50 percent of public firms survive beyond ten years. Our analysis of the BDS data also reveals low survival rates. Exhibit 15 shows one-year and five-year survival rates based on the birth year of the establishment. The rate today is similar to that of 1977. The latest figures show one-year survival rates of about 75 percent and five-year survival rates of roughly 45 percent.

Berry writes that “high gross margins are the most important single factor of long run performance. The resilience of gross margins pegs companies to a level of performance. Scale and track record also stand out as useful indicators.”

But if you can’t see how or where a company adds value for customers in its business model, then you can be pretty sure that it won’t be a 100-bagger. Unless it strikes oil!”

And bigger companies tend to cement their advantages. “Larger companies appear able to sustain returns for longer by finding efficiencies in SG&A that small companies cannot,”

It is great to have a moat, but true moats are rare and not so easy to identify all the time. Therefore, you should look for clear signs of moats in a business—if it’s not clear, you probably are talking yourself into it— you may also want to find evidence of that moat in a firm’s financial statements. Specifically, the higher the gross margin relative to the competition, the better.

In it, he gets at the boredom arbitrage: “Usually the market pays what you might call an entertainment tax, a premium, for stocks with an exciting story. So boring stocks sell at a discount. Buy enough of them and you can cover your losses in high tech.”

“Management is better seen than heard.” First, do your work, and only then, talk with management. “If I were to shake hands and like the people, I think that would really cloud my judgment.” This is an important admission. Even Block says he can’t resist the charms of management. Here’s his advice: Reading conference-call transcripts is better than listening to them. Read several quarters at a time to look for disappearing initiatives, changes in language. Are questions ever evaded? Which ones? “Sometimes they call on the same people and they have a rapport with them,” Block said. You know; it’s the calls that go like this: “Great quarter, guys.” “Thanks, Mike.” If the transcript is filled with that and there are no pointed questions, then it “smells like a stage-managed call.” In summary, it is “best to keep management at a distance.”

Investing is tough for a lot of people because they expect they can trust the opinion of experts. Yet in the world of markets, the so-called experts get an awful lot wrong.

Note how the consensus never gets the extremes. The consensus always forecasts a middle ground. The same general pattern of error holds for all kinds of forecasting, including forecasted earnings per share and market prices. The problem is, of course, that the extremes are where you make (or lose) a lot of money. Consensus forecasts aren’t worth much, whether right or not.

“Extraordinary performance comes only from correct non-consensus forecasts,”

Sosnoff’s law. This comes from a book called Humble on Wall Street, published in 1975 and still one of the best books on the experience of investing, on what it feels like. Its author, Martin Sosnoff, wrote that “the price of a stock varies inversely with the thickness of its research file. The fattest files are found in stocks that are the most troublesome and will decline the furthest. The thinnest files are reserved for those that appreciate the most.” In other words, the best ideas are often the simplest. If I find myself working really hard to justify keeping or buying a stock, I think of Sosnoff’s law. I’ve wasted countless hours on bad stocks and bad businesses. Many great investors have some version of this truism. (Peter Lynch comes to mind: “Never invest in any idea you can’t illustrate with a crayon.”) Simplicity is best.

“My purpose is to buy securities where I am satisfied as to assets and ultimate earnings power and where the market price seems cheap in relation to these.” He also became more patient. Giving an example, Keynes described how it was easier and safer in the long run to buy a 75-cent dollar and wait, rather than buy a 75-cent dollar and sell it because it became a 50-cent dollar—and hope to buy it back as a 40-cent dollar.

Keynes also came to the conclusion that you could own too many stocks. Better to own fewer stocks and more of your very best ideas than spread yourself too thin.

In a memorandum in May of 1938, Keynes offered the best summing up of his own philosophy: careful selection of a few investments (or a few types of investment) based on their cheapness in relation to their probable actual and potential intrinsic value over a period of years ahead and in relation to alternative investments; a steadfast holding of these investments in fairly large units through thick and thin, perhaps for several years, until either they have fulfilled their promise or it has become evident that their purchase was a mistake; and a balanced investment position, that is, a portfolio exposed to a variety of risks in spite of individual holdings being large, and if possible, opposed risks. Here is one last bit of advice from the same memo: In the main, therefore, slumps are experiences to be lived through and survived with as much equanimity and patience as possible. Advantage can be taken of them more because individual securities fall out of their reasonable parity with other securities on such occasions, than by attempts at wholesale shifts into and out of equities as a whole. One must not allow one’s attitude to securities which have a daily market quotation to be disturbed by this fact. If these ideas were good enough for the Great Depression, they’re good enough for whatever comes next now.