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Mistakes investors make in identifying and holding on to multi-bagger stocks

The sharp rally from March 2020 has given many a false sense of confidence. Avoid investing on borrowed confidence and tips given by friends or relatives

February 23, 2021 / 09:33 AM IST

Everyone loves to pick multi-bagger stocks. Though the framework to select multi-baggers is quite well-known, we hardly find investors having stocks that multiplied several times in value in their portfolio. Here are some mistakes that investors make in identifying or holding on to multi-baggers.

Fundamentals: You don’t know what you don’t know!

Investors in general have evolved and they are quite aware of the fact that they are not buying stocks, but are investing in businesses. Hence, an understanding of businesses is a must. But given the dynamic world we are living in, even sound and fundamentally strong companies can go out of business and that is what I meant with “we don’t know what we don’t know.” A company which is fundamentally sound and strong today may not exist tomorrow. This may be because the very problem which that company is solving now may not exist tomorrow or their products may no longer be needed. There are enough examples such as Kodak, Nokia and Blackberry, which were the market leaders of their time.  Though one cannot predict everything, there is a strong need to identify businesses in this light.

Too much focus on the P/E multiple

There is a constant talk about the Price/Earnings (PE) ratio, but when it comes to identifying a multi-bagger, a high or low PE may or may not make a huge difference. In fact, look at the TESLA stock, which defies rule and also proves the “greater fool theory” that people are willing to pay a much higher price in anticipation of disruptive growth in future. So, do not focus too much on buying a low PE stock; rather, look out for disruptive opportunities while identifying a multi-bagger.

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Do you understand the sector well?

Always remember the fact that every stock has a story and you need to pick up those sectors which you understand and believe in. You may also look out for the sectors where you have a core competency like your immediate work area, be it the Information Technology (IT), fast-moving consumer goods (FMCG) or any other industry. Avoid investing on borrowed confidence and the tips given by friends or relatives.

For example, someone in the financial services sector may understand the importance of how the overall life insurance, health insurance and equity market landscape will evolve in India. Examples of leading players include HDFC Life, SBI Life, or AMC or financial firms’ stocks such as HDFC AMC or Aditya Birla Capital.  So, choose a sector which you understand and you can find enough multi-baggers across sectors as we did in the past, with the likes of Berger Paints, Bajaj Finance, Balkrishna Industries, Eicher Motors and many more.

How many MRFs do you have?

We give too much importance to identifying a multi-bagger than holding on to that stock. Take my word, making money is really easy unless you are in a hurry. Though it is easier said than done, let me share a real-life case of my friend’s father who is holding on to the MRF stock which he purchased at Rs. 18. Guess the current market price? It’s Rs 88,906 per share!

Now, how can you beat that? A person has seen the price go from Rs 18 to Rs 89,000, and yet resists the temptation to sell. It is indeed a very difficult task and that is where the test of your patience comes in where most of the investors fail. That is why having a concrete plan and knowing why you invest in a particular stock in the first place is very important to decide your exit strategy.

Diversify, but don’t become a mutual fund

Over-diversification will never allow you to have a multi-bagger. Instead, it’s better to go deep with a maximum of say six to seven stocks from different sectors or on the basis your risk profile and return expectations. Diversification is important for your overall asset allocation but not with respect to your stocks, so in case you invest in too many stocks which many do, then you would eventually be running a mutual fund scheme of your own. And that process may get you a decent return but never exponentially higher returns which is the objective behind a multi-bagger.

The role of Luck

Like it or not, luck plays a small role. I doubt those who claim to know which stock can become a multi-bagger in future. This is important for you to know given the current COVID times and the way many new-age investors who made good money since the lockdown period. The recent sharp rally in the markets and your recent success may not be repeatable often.
Rishabh Parakh is a Chartered Accountant and a founder of Money Plant Consultancy
first published: Feb 23, 2021 09:30 am

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