Chris Mayer, the co-founder at Woodlock House Family Capital, and author of 100 Baggers: Stocks That Return 100-to-1 and How To Find Them, recently released a great article titled – Reflections on 100 Baggers in which he discusses the next 100 baggers, industry sectors to look in, and the key ingredients of a 100 bagger. Here’s an excerpt from the article:
“What is the key ingredient to a 100 bagger?”
Ah well, always the big question. In my view, the key ingredient is return on capital. That’s the gin. And the ability to reinvest is the vermouth.
Now, return on capital is a vague term. And this is an area I am still refining. But broadly considered, the key ratios to consider include “return on invested capital,” or “return on capital employed” or “return on assets” or “return on equity” or…
You get the idea. You can google any of these terms and get formulas. Which one you use will partly depend on the business you’re looking at and what makes sense. But the basic question you’re trying to answer is how good of a business is this? In plain english, we want a really good business and a really good business is one that generates a high return on the capital invested in it.
And since the road to 100 baggerdom is a long and twisty road with lots of hills and valleys, you can’t just do it one year. You want a business that can crank out those high returns year after year. That means you have to think about a lot of other things as well, like competition and growth potential and the ability to withstand economic cycles, etc.
So, that’s return on capital. But what about the ability to reinvest?
The ability to reinvest means that — again, ideally — you want a business that can take all of its profits and reinvest them back in the business and earn that high return on capital again…. And again. And again. Etc.
In the real world, few companies can do this. There are taxes. There are capital expenditures you have to make just to keep the lights on. Few businesses can reinvest everything. And there are great businesses that require so little capital to keep growing that they generate tremendous surpluses of cash.
So, companies pay dividends… or do acquisitions… or just sit on cash… or blow the money building palatial headquarters. It happens. Therefore, just as return on capital leads you to think about different questions, so too with reinvestment. You’ll have to think about what a business does with the cash it generates. Capital allocation becomes important. You have to think about management.
But at the end of the day, the two most important things are again: a high return on capital + the ability to reinvest. (Stir in a coffee can and bury it. Because you also need time, the hidden key “third ingredient” of a 100 bagger. Think a couple of decades.)
If I had to re-write the book today, I’d really spend more time emphasizing these two points. In my mind, when I think of a “high quality business” I’m really thinking of a business that scores pretty well on these two points.
You can read the entire article here:
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