What Are Multibagger Stocks And Why Do People Invest in Them?

New investors have always been attracted to the stock market by the possibilities of high returns. That is why investors are lured in by stocks that offer profits multiple times their initial investment. These stocks are called multibagger stocks, and they can help you grow your wealth in a relatively short period. However, it takes a lot of effort to find shares with such enormous growth potential. 

Read along to know more about investing in multibagger stocks.

What are Multibagger Stocks?

Multibagger stocks are those that generate returns several times their initial cost of acquisition. These are undervalued stocks with a significantly high potential for growth, which makes them desirable investments. In an emerging market like India, these stocks can massively appreciate in value, resulting in ‘multibagger’ returns. 

Peter Lynch first coined the term ‘multibagger stock’ in his book ‘One Up on Wall Street’. It only tells you about a share’s features and does not represent a separate category of shares. Stocks that double in price are called two-bagger or double-bagger stocks. Similarly, a stock that grows 10 times in size is a ten-bagger stock. 

It is important to note that these stocks take a long time to deliver high returns. So, you need to be patient with these investments. Moreover, you will need a high risk appetite for investing in these stocks. 

How to Identify Multibagger Stocks?

There are no fixed criteria that determine if a stock is a multibagger. You need to identify high-quality stocks that are likely to grow into a multibagger over time. 

Here are some of the essential indicators of a multibagger stock:

• Earnings and price multiples: If a firm’s P/E ratio is growing faster than its stock price, it could show that the stock is multibagger. The P/E ratio is the ratio of a company’s stock price against its earnings per share (EPS). You can derive the current P/E ratio by deriving the EPS of the last 12 months and revenue. 

• The company’s past performance: The past financial performance of a business is a reliable indicator of its future scope. You will want to track the company’s revenue multiples every quarter. A business with low revenue multiples performing well in the market may be a multibagger. 

• Company size: The size of a company plays an important role in determining if it will become a multibagger. While larger companies are more stable, smaller companies with a smaller market share have a lot more room to grow. 

• Competitive advantage: Checking if a company has a competitive advantage is an efficient way to identify a potential multibagger stock. In today’s competitive world, companies that constantly offer better products/services at an affordable price can become market leaders.

• Debt levels: Every business has debt. However, the ones that grow to become multibagger usually have manageable debt levels. While the appropriate debt levels vary from one sector to another, the debt to equity ratio should not go over 30%.

Also Read: Stock Split: Why Companies Split Their Stocks?

Importance of Investing in Multibagger Stocks

The following are some of the reasons why you may want to invest in multibagger shares:

• Higher return on equity: Return on Equity (ROE) is the net income from a share divided by shareholders’ equity. When ROE increases, it means that a company reinvests its earnings back into the business. Multibagger stocks tend to offer higher ROE than usual, leading to higher returns.

• Possibilities of exponential returns: Historically, multibagger stocks have returned profits many times more than their initial investment. For example, an initial investment of only Rs. 1,000 can deliver Rs. 10,000 for a ten-bagger stock in a relatively short term. Investors willing to take high risks for substantial wealth creation can invest in these stocks. 

• The advantage of opportunity: Many shares tend to be undervalued in an emerging market as many investors do not realise the true potential of the stock. You can take advantage of the discounted prices of multibagger stocks to buy more shares. Then, you can sell your investments when the stock reaches its full potential. 

• Invest in game changers: These stocks allow you to invest in companies that can become renowned in the coming years. Companies with solid fundamentals can withstand failures and challenges and grow considerably over time. If you remain invested in such companies, you can reap large benefits over time. 

Risks Associated with Investing in Multibagger Stocks

Before you invest in a multibagger stock, you should be aware of its risks. Some of these are discussed below: 

• Uncertainty: There is no way anyone can be sure that a share would turn into a multibagger. As a result of market uncertainty, the expected share price may remain undiscovered, and investors can stand to lose their initial investments.

• Low liquidity: Many times, there is insufficient or incomplete information about undiscovered stocks, which could turn into a multibagger. Till their price discovery happens, it may be difficult for existing investors to sell shares. 

• Speculative investments: Unlike shares of a large and stable company, the value of cheap stocks is largely speculative. While investors are attracted to them in bull markets, they usually try to sell these stocks whenever there is a market correction. 

Also Read: What Is Dividend Yield, How To Calculate It And Why Is It Important?

Final Word

Multibagger stocks belong to companies with solid fundamentals whose intrinsic value has not been discovered by investors. If you have a high-risk appetite, you can invest in high-quality and affordable stocks that could grow into a multibagger. However, you may have to wait for a very long time to get substantial gains.

FAQs on Multibagger Stocks

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This article has been prepared on the basis of internal data, publicly available information and other sources believed to be reliable. The information contained in this article is for general purposes only and not a complete disclosure of every material fact. It should not be construed as investment advice to any party. The article does not warrant the completeness or accuracy of the information, and disclaims all liabilities, losses and damages arising out of the use of this information. Readers shall be fully liable/responsible for any decision taken on the basis of this article.