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100 Baggers Book Review

100 Baggers Book Review

Reading 100 Baggers by Chris Mayer should be a litmus test for a career in investing. If you read the book and aren’t immediately excited to find great investments, then being a professional investor is not for you. While I have recommended investing exclusively in ETF’S, this book certainly makes the case for at least trying to beat the index with part of your portfolio.

 

The book begins by rehashing the story of Thomas Phelps, who wrote the first book on finding 100 baggers, stocks that return $100 for every $1 invested. Phelps’s book 100 to 1 in the Stock Market focused on the 365 100-baggers he found from 1932-1971. The introduction also has a great chart showing how many years it takes to produce a 100-bagger given different annual rates of return. Even with a high annual rate of return like 36%, it will still take 15 years to produce a 100-bagger.

Time to 100 bagger

 

Mayer found 365 100 baggers from 1962-2014, which excludes companies with market caps below $50 million in today’s dollars, prior to their increase. Quite frankly this is a much larger number of 100 baggers than I expected.

 

So how do you go about actually finding a 100 bagger? Mayer describes several strategies and characteristics to look for, when trying to find a 100 bagger. The key factors to look for include focusing on smaller companies, companies that generate strong ROE’s over time, expectation for substantial EPS growth, low P/E multiples, and a strong management team with incentives aligned with investors. Additionally, time is probably the largest factor given that it took 26 years on average for the companies Mayer looked at to generate 100x returns. Ultimately, these factors are important regardless of the company size you are looking for. Even if you don’t find a 100 bagger, I’d be pumped to find a 10 bagger!

Be patient you’ll need to wait a while….

The average 100 bagger took 26 years to increase its value 100x, equal to a compounded annual return of 19.4%. And only 19 out of the 365 100 baggers Mayer identified did so in less than 10 years. You can see the full list below, and the list is dominated by technology, pharmaceuticals, and consumer related products and goods.

Fastest 100 baggers
Source: 100 Baggers, Bloomberg

Time is the key factor here. Even with a high compounded annual rate of return you will still need more than a decade to achieve a 100-bagger. One approach Mayer discusses, is the coffee can portfolio, where you identify the best stocks you can and letting them sit for 10 years. You’ll incur no transaction costs or taxes with this approach. There are some great examples discussed, including a description of the Voya Corporate Leaders Trust, which bought equal amounts of 30 major companies in 1935, and hasn’t made any trades since then. The strategy outperformed the S&P 500 over a 10-year period ending in 2015, and as of 2019 the Voya Corporate Leaders Trust had beaten the S&P 500 over the past 15 years!

 

While buy and hold is a great approach, you still must do due diligence on your investments after making the initial purchase. The expected lifespan of an S&P 500 stock has declined from 32 years in 1965 to roughly 20 years today and is expected to decline to close to 10 years by 2027. While some of this decline is attributable to companies being acquired or taken private, most of this decline is expected to occur due to technological innovation and increased digitization of every sector. For example, retailers have been hit especially hard over the past few years, even prior to COVID-19, due to the rise of e-commerce. As a result, you must continue monitoring your investments, even if you think they are in relatively stable sectors.

average lifespan of SP 500 companies
Source: https://www.innosight.com/insight/creative-destruction/

You can never have too much growth

In addition to the element of time, Mayer identifies company specific characteristics to look for. Key among these is substantial earnings per share (EPS) growth over time. To generate a 100x return, you need to find companies with strong growth prospects. Companies in mature industries or that are already large are unlikely to grow fast enough to produce such a large return. Of the 365 100 baggers that Mayer identified, the median sales figure was $170mn and the median market cap was $500mn. Once a company has already achieved a large enough market cap it becomes nearly impossible for that company to grow 100-fold.

 

Clearly not every small company becomes a 100 bagger, so what other criteria should you look for? High return on equity (ROE) is another key factor. ROE measures the return a company generates on the equity in the business. Companies that consistently generate high ROE’s, are generally able to grow EPS at high rates as well. It’s important that company maintain strong ROE’s, as this shows that the company has attractive investment opportunities over time. If you see a declining ROE trend, that typically shows that the company does not have attractive internal investment opportunities, which ultimately caps the potential EPS growth for that company. Additionally, its important to make sure that those high ROE’s were generated through strong profit margins as opposed to high leverage. For example, banks prior to the Financial Crisis were generating high ROE’s using substantial leverage, which ultimately magnified losses for those banks during the recession.

 

For a company to be able to grow its EPS at a high rate for a long period of time, it must have a sustainable competitive advantage compared to its peers. Warren Buffett frequently uses the term Moat to describe this process. Companies with strong moats are typically able to earn high ROE’s, so if you find a company with a high ROE, it’s crucial to understand what that company’s moat is to make sure that the company can sustain those high ROE’s for a long period of time. Mayer describes many potential moats in 100 Baggers:

Strong brand: allows a company to charge a high price and generate high margins due to perceived differences in quality, Tiffany’s and Tesla represent strong brands with premium pricing power.
High switching costs: when it is expensive for a customer to switch to a competitor, such as the nuisance of switching banks.
Network effect: the value of a product or service increases with the number of users. Examples include social media, search engines and operating systems.
Cost advantage: Being able to price your product below competitors should lead to higher revenue growth over time. This moat tends to be less durable, as competitors are typically able to lower their prices as well.
Largest player: Being the largest player in a market has key advantages and can result in a monopoly or oligopoly situation leading to greater pricing power and higher margins. Historically, newspapers were a great example of being a large player in a small market, and newspaper stocks performed extremely well prior to the growth of the internet.

 

Check out Bruce Greenwald’s Competition Demystified, to learn more about finding moats and competitive dynamics in an industry. 

One last point on moats, some industries can consistently generate much stronger ROE’s over time than other industries due to the industry structure in place. The below chart shows the substantial difference in sector ROE’s for the U.S. stock market, looking at sectors with at least 50 companies. ROE’s range from 31% for Aerospace and Defense to -8% for Oilfield Equipment & Services.

ROE by sector
Source:  http://pages.stern.nyu.edu/~adamodar/New_Home_Page/datafile/roe.html

Don’t forget valuation

Valuation matters of course. For a company’s market cap to increase 100x, you need to have the company’s P/E multiple increase in addition to substantial EPS growth. Mayer highlights the importance of lower P/E multiples, but also notes that “it is rare to get a truly great business at dirt-cheap prices.” Ultimately the higher the P/E multiple you pay for a company, the higher the EPS growth you will need. For example, if you buy a stock with a P/E multiple of 20 and the P/E multiple stays at that level, you will need EPS to grow 100x to have a 100 bagger. However, if you buy a stock with a P/E multiple of 5 and the P/E multiple expands to 20, then you only need EPS growth of 25x (still impressive) to achieve a 100x return.

The importance of quality management


There are a few good approaches to finding great management teams. One well known one, is to look for companies where management is also a substantial shareholder. Frequently this occurs when the founder stays on as CEO, TSLA, FB, and AMZN are great modern-day examples. But additionally, you can also find companies where the original founder is no longer the CEO, but the current management team owns a substantial amount of the company, with BRK being the best-known example.

 

This is a crucial factor, because you want the CEO’s interests to be aligned with your interests. When the CEO owns a large stake in a company they benefit just as much as other shareholders when a company does well. In fact, many of these owner-operators take a minimal salary and are largely compensated through the stock price performance. In 100 Baggers, Mayer discusses interesting research backing up this theory and highlights several investment managers (Horizon Kinetics, Virtus Wealth Masters Fund) who focus on this strategy and have achieved excellent results. In terms of academic research, Mayer cites a study by Joel Shulman and Erik Noyes (2012) showing that stock-price performance from company’s managed by the world’s billionaires outperformed their index by 7%/per year! That almost matches BRK’s 10.3% average annual outperformance over the S&P 500, from 1965-2019.

 

In addition to owner-operators, management should be highly focused on capital allocation, which is the CEO’s most important job. Ultimately, it should be the goal of the CEO to maximize the per share value, not the overall size of the company. Mayer highlights the book The Outsiders by William Thorndike which has detailed case studies on eight CEO’s whose performance crushed the S&P 500 over a long time period. These CEO’s utilized unconventional strategies to generate outstanding returns for investors using opportunistic share repurchases, acquisitions as well as asset sales to increase per share value of their companies. They also worked to minimize taxes, focused on cash flow over reported net income and disdained dividends.

Case Studies and list of 100 baggers

100 Baggers also includes case studies on companies such as Monster, Amazon, Electronic Arts, Comcast, Pepsi, and Gillette. It’s fascinating to see how these companies were able to consistently grow their EPS and increase their P/E multiples over time to generate 100x returns.

 

Finally, the book concludes with a list of all 365 100-baggers Mayer identified from 1962-2014. It’s amazing how many of these are well known companies across a variety of sectors: consumer (Amazon, Starbucks, Monster, Harley Davidson, Williams Sonoma, Best Buy), Tech (Apple, Microsoft, Oracle, Cisco, Dell, Adobe) and Media (Time Warner, Electronic Arts). In hindsight it is easy to imagine these companies being great investments, but hindsight is always 20/20 and few investors held on to any of these names for their entire journey to becoming 100-baggers and more.

Conclusion

This was an enjoyable read and extremely inspiring as well. Most investors don’t try to hit 100-baggers, but instead hope to hit doubles or triples. By expanding the range of what’s possible, 100 Baggers serves as an inspiration to investors. In terms of areas for improvement I would have loved to see additional case studies, and it would be great to see this book updated for 2020, especially with the rise of the FAANG’s and other tech stocks that have become 100 baggers over the past few years. Additionally, it would have been great for Mayer to include more data on companies when they start their 100-bagger journey, such as the median ROE, P/E multiple and EPS growth, and sales growth.

 

To get started looking for 100-baggers, I recommend using a free online stock screening tool such as: finviz. Using that screening tool, you can search for companies that fit the criteria we discussed above: small cap companies with high ROE’s (above 20% is a good starting point), strong sales and EPS growth, and reasonable P/E multiples. Additionally, you can screen for companies with a high percentage of insider ownership, which includes a company’s executives and directors. This is a great starting point to narrow down your list of potential 100-baggers.

Good luck in your search!

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