Identifying multi-baggers: Chris Mayer, author of 100-Baggers, shares the key metrics that drive his investment decisions

Identifying multi-baggers: Chris Mayer, author, 100-Baggers shares the key metrics that drive his investment decisions

The best businesses trade at high valuations because they are well discovered but investors shouldn't be too value sensitive, said Chris Mayer, portfolio manager and co-founder, Woodlock House Family Capital and the author of 100-Baggers. In a conversation with Moneycontrol for its Global Wealth Summit, he gave an example of a company called Copart he bought at a high valuation. The car-parts auction company generates very high capital, reinvests everything, and it is very difficult for competitors to replicate its business model, he said. Edited excerpts:

You have done a lot of work around finding 100 baggers. Tell us your framework.

You have to find companies that generate high returns on capital so they are profitable and they’re able to reinvest those profits to grow at the same attractive rate. To do this, I have spent a lot of time figuring out the market size and its competitive advantages.

The challenge that most investors face with high quality companies are they are well discovered and trade at high valuations. So how do you navigate this?

The best businesses usually trade at healthy multiples because they are well discovered. There is some limit that you can't pay above or your returns are going to be pretty mediocre, but that price is often a lot higher than people think.

If you think a 25% return compounded over 10 years is a six-fold increase in EPS. Then you're not worried whether you're paying 25 times or 30 times or 35 times as it kind of bleeds out in the background over a long period of time. Another things which can be done is to buy a little now and then buy when you get chances down the road.

But I would discourage people from being too valuation sensitive. If you have a truly great business that is going to go up 50 times or 100 times over 20-25 years, I wouldn't worry too much about your initial entry price.

It is more important to be in the right business than necessarily have a super attractive entry price.

There is so much disruption due to AI, climate change, newer distribution model where a lot of businesses are getting challenged. How do you assess durability of a business considering these disruptions?

If a business has been around for a long time, it has some competitive advantage that is difficult for competitors to replicate. One must dig into things like market share, stability of market shares and try to figure out why a particular company is able to succeed in its market and whether that can withstand competition. We should also look if the customers are sticky.

Any example of the company where price was a tad too much but the growth really justified the price?

Copart is a company that deals with totalled vehicles. If you get into an accident and your car is declared a total loss, it will likely end up in a Copart lot, where it is auctioned off to buyers.

This business generates very high returns on capital and reinvests everything. It is also extremely difficult to compete with them because these salvage yards often contain thousands of cars, and building new ones is challenging, particularly in the U.S. due to zoning laws and other restrictions. Copart has been acquiring land for 20 years, making it even harder for new entrants to compete. They have a network of buyers bidding on these vehicles.

Given the high returns on capital, Copart often trades at high earnings multiples. In 2021, I recall discussing this with an investor on Twitter (now X), when the stock was trading at around 40 to 45 times earnings. Since then, the stock has more than doubled, as its growth has exceeded investor expectations.

I have owned Constellation Software for a long time, which follows a similar pattern of strong capital returns and consistent growth. The multiples for the stock have been high for years but it hasn't prevented the stock from performing well and even outperforming expectations of its investors. So, great companies with great management teams often surprise you on the upside as well. And there can be new verticals and new avenues of growth that you didn't necessarily plan on.

What kind of valuation metrics you use to value high growth companies? Does interest rate have a significant bearing on companies like this?

Interest rates fundamentally impact the cost of money, but some businesses are more sensitive to interest rate changes than others. A business that requires a lot of capital and relies on borrowing will be directly affected by interest rates, as higher borrowing costs can impact its performance. However, the businesses I own tend not to be leveraged, carrying little to no debt, so interest rates typically do not impact them.

High interest rates can influence acquisitions, as some of my businesses are involved in acquiring other companies. In such cases, higher rates can make acquisitions more expensive.

I focus primarily on cash flow. Since I invest in companies that generate significant cash and reinvest it for growth, I don’t want to penalise them for reinvesting. For example, if I own a company like Copart, which reinvests a large portion of its profits into acquiring new land for yards, I evaluate cash flow before these investments. My goal is to determine the stabilized free cash flow and assess my yield on that.

A simple way I approach valuation is by looking at a company's return on capital and reinvestment rate, projecting those figures over five to ten years, applying a multiple, and then discounting it back to today to determine the overall internal rate of return (IRR). I focus on this five-to-ten-year outlook because relying solely on free cash flow yield can be misleading—it provides only a snapshot of the present, whereas I want to understand the business's potential over the long term.

What kind of metrics would you use for companies at early stages of growth? For example, a number of digital plays which may be investing for future especially if you don't see profits coming through in the near to medium term?

I'm only investing in situations where companies are generating cash now, where there's a return on capital, where I can see there's already an established track record for that. It doesn't mean you can't have a great deal of success investing in early. That's just not my, that's not how I invest.

How do you assess durability of a business?

Assessing the durability of a business starts with understanding the nature of its products. Are they essential and resilient? For example, in the case of Copart, cars will get totaled in all economic cycles, so it is not a cyclical business. Another example is insurance brokers for businesses. In the U.S., companies are required to have various types of insurance which is a mandatory expense for them. Since these are not optional purchases, they contribute to the business’s durability.

One can look at difficult to gauge things like employee turnover. Do employees stay, and do they like working there? Retaining talent is crucial for long-term stability. Customer relationships also matter. Do customers stick around? Are they willing to pay higher prices? Can the company pass on cost increases to protect margins?

In today's market, how easy or difficult is it to find 100 baggers?

Finding 100-baggers in today’s market is both easier and more difficult than in the past. It's harder because there's a lot more competition, with more investors searching for the same opportunities. The availability of free resources has grown significantly. There are blogs, Substacks, and investors openly discussing their portfolios and ideas, making it easier to discover potential high-growth stocks. But in the end it is never going to be if it would have been easy then everyone will have 100 baggers.

Where do you see value? Any particular geography?

I don’t have any specific hunting grounds where I see value. I’m looking all over, as there are always interesting smaller-cap names to explore. But I can’t point to a particular geography or industry that stands out. We’re in a period where there isn’t a clear area of greater value, which is unusual, as there are typically pockets that seem more attractive than others. So, it’s a tough question, and I don’t have a definitive answer—it’s all over.