Here are two ways you can spot those elusive ten baggers.
It's every investor's dream, a ten bagger, a share that goes up at least tenfold. Most investors of a certain age have probably had one at least one in their portfolio and many others may have, inadvertently, let one slip away.
In the search for such a gem it's important to keep a cool head and realise that the odds against you are high. Potential ten baggers normally carry a high degree of risk, so should only form part of a balanced portfolio of investments. You must also be prepared to cut your losses quickly should it disappoint.
In my experience, the shares that invariably turn out to be ten baggers are either recovery plays that are basically sound but have fallen out of favour with the market or great growth shares that are so small that they've been overlooked by the professionals.
Recovery stocks
In volatile markets with nervous investors, such as the one we're in now, a share de-rating can easily be overdone. Here lies the opportunity.
The risk with buying a recovery play is that you have to be spot on with your timing and sufficiently confident to go against the herd. That's why the adage that you should buy what you understand and hold for the long term certainly makes sense. If you still have no idea what a company does after you've read the annual report it's probably best to leave it well alone.
Its pre-tax profits will have dropped and it may even be making a loss but you should see scope for it to remedy this situation, perhaps by cutting a loss making venture. It could also be the case that its profit was hit by a one-off charge that won't reoccur.
Certainly, you need a company with strong fundamentals and a high quality of earnings, that is able to fund development internally or through carefully managed debt. By carefully managed I mean avoid companies that are highly geared especially if the debt is in the form of a bank overdraft rather than bonds: overdrafts are payable on demand and bonds are not.
Growth shares
Penny stocks have more chance of delivering a ten bagger performance but beware of much of what is touted on the AIM market. Usually, by the time a company has its IPO, the VC boys are heading for the exit, having taken their profits it is the likes of you, or I, that are left with something that has been overhyped and is overpriced.
A potential ten bagger will normally operate in a growth market, has a strong cash position and a Price Earning Growth Ratio (PEG) that is below 1.
The PEG of a company is calculated by dividing its prospective P/E ratio by the estimated future growth rate in earnings per share of the company. As the estimated future earnings are a critical part of the PEG calculation, it is best to use consensus forecasts, rather than the forecasts of any single analyst (unless you have particular faith in any single one).
The share in question will have been overlooked by the big brokers because they can't cover all the market and it is just too small, yet an examination of its accounts should show that its profits are increasing and its turnover is growing markedly.
But, before you invest, you also need to look at its cash flow statement and rate of cash burn. Many, many prospective ten baggers fall by the wayside because management fails to manage cash flow. In the past, I've lost money on a company that seemed to be about to make a fortune, and then went bust before it could capitalise on its product in a potentially lucrative market.
Similarly, if a company keeps on issuing shares and misjudging its cash burn avoid it. Controlled cash burn is a function of good management and the reverse is also true.
If you do your homework you should eventually end up with a couple of shares that could develop into ten baggers.
Selling too early
But beware: the easiest way to lose a ten bagger is to sell it too early, after it has doubled or tripled, eager to crystallise paper gains. Perhaps the best way to avoid this disappointing scenario is to sell a proportion of your holding, to cover the original cost of the investment, or set a trailing stop loss. (Either way, you'll avoid an even worse scenario of not making any profit if the share subsequently falls.)
I remember buying Recognition Systems for 10-15p and selling for pounds as it flew to around £6 a share. It was a 10 and even 20-bagger for me but I didn't make it a 60-bagger, gradually selling before it peaked. If I'd had a few more and kept my holding till the peak, you wouldn't be reading this article now. (Or I'd have been emailing it from my holiday home in the Caribbean!)
> Join the ten-bagger hunt at Champion Shares! Lead Analyst Maynard Paton is always searching for great value opportunities and you can find out all his latest recommendations by taking out a free 30-day trial today.
