Investing sometimes can be like walking in a thick fog. The more haste you make the more is the probability you land in the same spot you started with.
When it comes to investing in equity, one must have witnessed or come across various stock stories that have generated 10x to 100x returns,
Let’s understand the making of 10x returns in 10 years mathematically,
Given that the time horizon is 10 years, let’s consider CAGR as 25% over this period.
The above-stated line forms the main ingredient of the whole recipe. It is easier said than done.
Keeping this in mind, an investor is now prepared to invest with the horizon of 10 years, but the underlying question is ‘how to go about searching stocks with 25% CAGR potential’.
First of all, let us spot seeing equities as stocks.
For 10x in 10 years, one needs to start viewing equities as businesses.
Each business has a set of competencies, challenges and fall in different level of competition.
There are 5 filters for which a business has to fulfil to fall in the real potential to generate 10x in 10 years or more.
Let’s understand them in detail.
The characteristics are as follows:
- An existing Company must have an Operating history of minimum of 10-11 years.
10-11 years is considered a good filter for time frame because we can see at least 2 economic cycles and 2 political cycles and some natural catastrophise.
This period showcases the true character and quality of the organization because even if the business falls the actual test lies in how fast the company recovers.
- The Operational Cash Flow must be consistently growing.
Ultimately, we all know that ‘Cash is King’, what matters is what comes in the bank account. These numbers are verified both by auditors and bank can rarely be manipulated. Operating Cash flow growth of 15-20%.
- Zero Debt Business
Let us do some number crunching here,
If a company’s Y-o-Y volumes grow by 10%, sales by 20% and operating cash flow by 20%, every 4 years you are doubling in terms of cash, why will a company need debt. Even if it wants to expand faster, look for those companies that rely on internal funds over raising debt. Even if it goes wrong, it can walk over the decision, unlike a debt-laden one which will have to serve the debt even after the wrong decision is over.
- There must be Volume growth with pricing power.
As the economy grows, the Market expands.
But the expansion supports only those businesses which have a strong underlying product addressing the need of the consumers at an acceptable price. There are some companies that grow faster and hence identify these companies which grow faster than India’s GDP is what Y-o-Y volume growth tells us. And hence not to forget the inflation,
Volume growth + inflation + brand premium = Sales value growth.
Ideally,
Volume Growth of 10% + Sales Growth of 20%.
- Promotor participation in the business game.
At least 70-80% of promotors’ income comes from such businesses. And, the promoter should be focused to invest close to 100% of his professional bandwidth in this company being picked for investment.
Ideally, 70-80% of promotors income and 100% professional bandwidth dependent on the business
All of these factors form the basic building block of selecting a good business – for example, Reliance Industries has just turned debt-free, but the growth might still be sublime for a while. One has to look at all these filters in combination and not individually.
After selecting allocation to each business is another element, that matters a lot when creating such a portfolio.
Allocation is one of the silenced aspects in wealth creation, the right allocation strategy can make or break portfolios, this is because proper allocation strategy ensures diversification and concentration at the same time.
Diversification portfolio at sectoral allocation level and buying only the best from each sector ensures they provide superior returns and near market volatility.
If one has done justice and provided a fair amount of time on research as mentioned in the above 5 filters, a portfolio of 10-15 businesses is needed for a potential return of 10x in 10 years.
Challenges in equity investing on their own: –
- Discipline – Apart from keeping emotions under control, it’s important for you to understand to stick around stocks you believe have a good business, will correct in bad times.
- Predicting things too early – Individual investors might often assign more value to the stock price than the intrinsic value of the business. Stock Prices change more often than Intrinsic value and investors tend to feel some action must be taken and lose out on wealth creation.
- Testing your Patience – few days make the most returns in markets, and unfortunately, one can’t pick and select these days so one has to stay invested which becomes a challenge for most investors.
- Good businesses might not remain good always, so one needs to check regularly which might be difficult for individual investors and hence one must periodically consider rebalancing if necessary.
10x in 10 years is highly possible in Equities.
One need is to ensure one creates a moderately high degree concentrated portfolio of the right businesses based on 5 filters explained in this article, holds & be keeps a watch on the businesses over a longer time (evaluating its financials quarterly), keeps a minimum of 10 years of the horizon with discipline. Since all this could be highly difficult for a lot of investors, it is suggested to find the right fund manager.
