MI276: Finding 100 Bagger Stocks w/ Chris Mayer

0:00You're listening to TIP. On today's show, I chat with Chris Mayer about finding 100 bagger stocks, what to look for, how to find them, what metrics to analyze, how to think about valuation, the company's management team, and much, much more. Chris is the portfolio manager and co-founder of Woodlock House Family Capital and offer of the book, 100 Baggers. Chris spent a lot of time studying and really digging deep into companies that have become 100 baggers over time, what characteristics they have in common, and how we can identify these companies or the next 100 baggers today in advance. And not without further delay, I hope you guys enjoy this week's episode with Chris Mayer.

1:05Robert Leonard Welcome back to the Millennial Investing Podcast. I'm your host, Robert Leonard. And on today's show, I am joined by Chris Mayer. Chris, welcome to the show. Chris Mayer Good to be on with you. Robert Leonard I want to start today by talking a little bit about the study you did for your book, 100 Baggers, which is all about how to find stocks that can give you 100X your return. My understanding that you spent a lot of money on this study and the book and a lot of time and energy finding these sample of stocks that have gone on to become 100 baggers. Give us a little overview of your process and what you found.

1:40Robert Leonard Sure. Yeah. So it was inspired by a book that came out in 1971 called 100 to 1 in the Stock Market by Thomas Phelps. And he had done this study where he looked at all the stocks that had gone up at least 100 times. I think he started it in the 30s up to when he published his book. And I love that book. And then I had a friend of mine who suggested, hey, you should update it. So, that's what kind of inspiration came from. And so, yeah, I mean, the trickiest part was getting all the data together. So, that took some time and money. I didn't work with another analyst to help me kind of extract everything.

2:11And then we found about 365 names that had gone up at least 100 times, which ironically is the same number that Phelps found in his study. And that was what we did. I mean, I had some market cap limitations. So I cut off some of the very smallest stocks because I was trying to get something that we could maybe see some predictable traits in the financials or in the business itself. So I took out those little tiny mining stocks that go maybe from 15 cents to$15 or whatever. So that was basically the universe. And there were a lot of interesting things that I found. I guess we can get into those as we go along.

2:45A couple of the examples are Pepsi, Monster Energy, and Amazon. And it's hard to generalize these three situations or scenarios because they were all so different. Amazon looked too expensive. Pepsi always kind of seemed underwhelming. And then Monster Energy just went through so many ups and downs. So I know it's difficult to generalize, but what were some of the common characteristics that you found common to all the hundred baggers that you studied? You said it very well. I mean, that's one of the things too. When I did the study, it was very hard. I thought going into it that I might be able to get kind of a template or I might be able to generalize what some of those things were.

3:26But as I got into it, yeah, they were very different. I mean, even in terms of margins, kinds of businesses they were in, a lot of differences. But I guess if I were to really kind of force myself to think of some commonalities, and I talk about them in the book, I mean, one is, of course, the businesses all grew a lot. So, you know, all these businesses were much, much larger after their journey when they started. So, you You have to find businesses that are able to grow. And so what are some of those key components of growth? Because not just growth, but you want profitable growth. You want growth that's economic.

3:57And so I would say these businesses all generated very high returns or high returns in their capital and they were able to sustain that year after year after year for decades. If you look at the whole population of 100 bankers, it kind of formed this little bell curve. Most of the names kind of fell in that it took 20 to 25 years time, which is about 20 to 25 % a year in annual compounding. So, that kind of sets the parameters. Outside of that, then you have to have things like, I mean, you have to be able to survive all the ups and downs of the cycle. So, you know, many of the businesses had pretty good financial, you know, pretty good balance sheets or pretty good financial shape.

4:33And many of the businesses had some sort of entrepreneur behind them. So, this was another, not a critical theme. There were many exceptions, but it seemed like a lot of them had some entrepreneur. So, you know, you think about Walmart and you think about Sam Walton, or you think about Apple and you got Steve Jobs. And there's always, not always, but there was often an entrepreneurial force, at least in the beginning. It could be an entrepreneur or a family of some sort. So those were some of the things that they had in common. Talk to us a bit about how early an investor needed to be in these companies to get 100x their return or 100x their investment.

5:08Did they have to buy into the company at the IPO? Could they get on a little bit after the IPO or were there a bunch of opportunities throughout these companies history that an investor could have 100x their returns? Yeah, this is maybe a misconception people have and they think they have to be in really early. But with these 100 baggers, you had many opportunities and often you could buy them year after year. You could pay the 52-week high price for that year and the year after and the year after and still make 100 times your return. So yeah, I mean, the lesson there is it's not so much about market timing or how early you were.

5:41I mean, there have always been stories, for example, with Berkshire Hathaway, even when he was not even halfway through the journey where people would speculate whether it was already done or it's already played out. And so you have to resist those. I like to say, focus more on that underlying engine, the business itself and how it's compounding and not worry so much about where you are and where you are and the age of the company. You don't have to get in, like you said, at the IPO. You mentioned how the company needs a long runway for growth, and that's typically easier with a smaller company.

6:15So what can you tell us about the market cap of these companies? Yeah. So I think the average starting market cap, if I remember, it was less than 500 million and the companies were fairly substantial businesses already, I think 170 million or so in sales. And so it's not like they're tiny, but they're certainly not 30 or$40 billion market caps either. So I think my opinion has changed a little since I wrote the book because when I wrote the book initially, I think in there, I told people to focus on market caps. I forget what the number was, 300 million or 500 million, pretty small. But I think you can relax that a little bit.

6:50I don't think you should hesitate. If you find a really good business that meets all these other things we're talking about, but it's got a$2 billion market cap or$6 billion market cap. I don't think you should avoid it or pass it on because it's really hard to predict what company will get to 100X. I wouldn't try to imagine necessarily that it goes up 100X. I'd focus on, again, does it have those characteristics? Does it have a really good business? Does it have a mode it can defend? Is it something that seems like it can compound for a decade or more? And then you kind of follow the story and see who you go.

7:21I mean, the thing about it is, and I talk about this in the book, if you aim big, you aim for that 100X and you don't get it, you're probably still going to have a pretty good result. I mean, if you get 50 times or 25 times your money, I think everybody will be very happy with that. I think one of the hardest parts of buying 100 baggers is the mentality or psychology piece of it. I mean, of course, finding these companies, finding these opportunities is very, very difficult, But that's step one. Once you've done that, the hard part is really being able to weather the storm. I mean, you look at Amazon and it looks like it was a given.

7:58If you look back now, hindsight's 20-20, it seems like everybody should have been involved. But if you zoom in, there have been periods of time where these companies have lost a lot of money. You have to be able to weather the storm. Companies have lost more than 50 % of their value at some points, some companies even multiple times. You have to really have the kind of wherewithal or the gut to stomach these types of things. Talk to us a bit about the mindset that you need and what type of investor you need to be to hold these stocks to get these 100X returns. Yeah. You have to be very patient and you have to be able to take the ups and downs and not only ups and downs, but then there's long stretches where the stocks went nowhere.

8:37So I usually say Berkshire Hathaway, for example, was the best performing stock in that study. And even that stock at at least three different times or it was cut in half. And then just as difficult, there was a seven-year stretch where it went nowhere. So think about that. I mean, some of these stocks require you to hold on to them for years and they went nowhere. And this was right in the midst of going up a hundred times. So the market will test your patience. And this is why I think it's important for investors who want to invest this way that they have a different scorecard other than just looking at the market price all the time and judging it, the investment by the market price, but looking at the business.

9:13I mean, is the business growing? Is it continuing to perform? One of the tables I remember from Phelps' book that really stuck with me and then I wind up having similar tables in my book where he used the example of Pfizer and he just shows some basic financial data over a 20-year period of time and he asks you if you would just seeing those figures, if you would ever sold the business. Of course, you wouldn't have because every year it was doing pretty well. But if you look at the stock chart during that time. So up, down, long stretches went nowhere. So this is a big part of it. I'd say this is probably every bit as challenging as just the idea of finding the great business to begin with is then having the ability to hold onto them.

9:53I know you just mentioned some of the things on your checklist now, but what are you looking for in terms of qualitative metrics and also quantitative metrics? Break down your checklist for finding great businesses a bit more. Robert Leonard Quantitative metrics would be, I just say return on capital because I know that's kind of vague, but I mean, it's because I look at a lot of different things. I mean, I look at return on equity, return on invested capital, return on capital employed, and these are all just standard definitions. You can Google and see how they're calculated. A lot of financial websites these days even calculate them for you.

10:24But we know that getting that 100 bagger level is basically a math problem at the end of the day. If you compound 25 % a year, you're going to get there in 20 years. And you're not going to hit that every year. Of course, there'll be some years down, some years up, but you want a business that can compound capital at that kind of rate. So, once you find businesses that are like that, that have those good returns, then you really have to kind of dig in and figure out why they earn those returns. Because we know the nature of capitalism is that there's going to be competition. If you're over there making all kinds of money, it's not like you're just going to keep doing it and no one's going to pay any attention.

10:59People are going to be like, wow, she's making all kinds of money in her business, maybe I should do something similar. And that's what kind of brings down those returns on capital is having a lot of competition. So I spend a lot of time, and I would recommend this is where investors should put most of their time, figuring out what makes that business special. Why are they able to earn those kinds of returns? What kind of competitive advantage do they have over their competition? And how are they going to be able to protect that return over a long period of time? Those are the essentials right there.

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14:05To begin getting smarter about investing, just visit theinvestorspodcast.com slash get started with stocks. That's theinvestorspodcast.com slash get started with stocks. And for a limited time, you can use code stocks15 for a 15 % discount at checkout. All right, back to the show. Maybe it's just my perception, but it does seem like these days, it's getting harder for companies to keep their competitive advantage for 10 or 20 years. Whereas Because maybe a couple of decades ago, it was easier to maintain a competitive advantage and reach that 100-bagger status because you need to usually hold it for 10 years, generally, like you've said.

14:47So this competitive advantage piece and the time in which a company is able to hold their competitive advantage is interesting, something to think about. So how do you reconcile these two kind of ideas in the companies that you look at? Yeah, I think that's objectively true, what you're saying. I mean, we see it in the corporate lifespans of businesses that are coming down, they're briefer. So, it's definitely tougher nowadays. And yeah, I mean, I think that's true and something you have to be aware of. And sometimes, you know, I think about sometimes I rewrote the book, I might have to have a chapter on what sort of unmakes these 100 baggers.

15:26But certainly, I think you have to be aware of technological change and obsolescence. So, some businesses are more subject to that. One of the things I pay a lot of attention to is just the structure of the industry, like how many competitors. Sometimes you're going to be a small player and there's just a sea of competition versus some industries are structured where there might only be one or two major players. So for example, there's a company called Copart. And in that industry, it's Copart and Insurance Auto Oxens. They're kind of a duopoly. So that kind of situation, just on the face of it, is more appealing than buying a company that has maybe 2 % of the market and there's 50 competitors out there.

16:01So sometimes that can give you a clue as well. But I would say, you know, you have to really focus on competition, where it's likely to come from, and then dig into those competitive advantages because some competitive advantages are better than others. You know, if your sole competitive advantage is you have a brand that you're able to charge more for, that's usually a good competitive advantage. But if you think out 10 years or longer, you know, it might not be the best because we've seen brands that kind of lose their luster, right? We could probably come up with some examples. But if you have something that's more difficult to break, like imagine you're trying to break a network effect, like say a Google, you know, how difficult it would be to get, first you got to get people to use your search engine.

16:39And that would be, you know, an example of a very strong competitive advantage, I think. So, there is a lot of qualitative stuff as well, which is hard to, you know, give you a definite checklist where you can say, well, this is, you know, this is what you want to see. It's an analysis you have to do and think about and compare that competitive and how strong it is compared to what the competition is doing. How often do you reassess the competitive advantages of the companies that you're invested in? Is it every time you're keeping up with the company? Is it yearly? What seems like a red flag and makes you potentially want to sell the stock if you think it's gone that way and maybe their competitive advantages are gone?

17:19Yes. And this is getting to a very difficult subject of investing is like when to sell. It's probably the hardest decision of all. So, the one is when your thesis changes, people say, and that's a good longstanding investment wisdom there. But what does it mean when your thesis changes? What do you really see? So, I think it's a great question. And I think there are no easy answers, but when you buy a stock, what I do is I write down, I have internal memos and things I write down why I bought it and be very clear and specific. And when those things start to change for the worse, that's when you really have to reassess what you're doing and it might be time to leave.

17:56You know, I look at every quarterly release that comes out, but I think that not much really changes in a quarter. So, I'd be reluctant to make any kind of change just because somebody had a bad quarter. Yeah. So, you know, I'd say like once a year, good assessment. And then it's not only that, but, you know, sometimes there's news that comes out if a new competitors has come into play here that you didn't factor in or didn't see, and your company starts to lose market share, that would be a big warning flag. It might be time to go. So it's really an ongoing assessment. It never really ends. But at least I would say for most people, you would want to check in at least annually, give it a good look.

18:33We've talked a bit about business quality and your checklist for quality, but how do you think about valuation in your investment process? And at what point would you maybe rule out a company that hits your checklist or satisfies your checklist for being a great quality company, but you just don't like the valuation? You just don't like the price? Yeah. Well, first you did the interview in the right order because it's definitely spent a lot more time on the business itself. And then that's the harder piece to fill out. And once you have that business, then you have to think about the valuation and price you're going to pay.

19:05And maybe you don't like the price now and you can wait. You maybe buy a little bit now and then you leave yourself lots of room to buy more as you go along. But the way I think about valuation is really kind of simple. And so, I have an estimate of what I think that business can earn, what kind of return on capital. And you kind of project out over five and 10 is usually what I do. And then put some sort of multiple on that that you think is reasonable. And then what's your IRR to present? So, it's hard to get what I call in the book, the twin engines, where, as you mentioned, you get multiple expansion along the way, that is like Nirvana.

19:39If you can find that, if you can find a company, a great business that checks all the things we talked about and it's out there for 10 times earnings and you own it and at the end of 10 years, it's trading at 40, that really helps a lot. Those are very hard to find though. You might get chances along the way where that happens, but they are hard to find. So that's really how I think about valuation. And then I have a certain hurdle that I want. And a lot of for at least 15 % compound annual return, but you can dial that up and down depending on what kind of assumptions you make. If you make different assumptions, you may have a different hurdle rate.

20:14So it's more of a personal thing there as to what you're going to make your hurdle rate be, but you have to think about valuation in that kind of context. This brings me back to your case study of Amazon. And I personally think of companies that I've found even after reading your book where they meet everything on my checklist. They've been compounding at a good rate for a decade or more. They have high returns on invested capital. They have great management, all of those things, but it's at a PE of 80 or even higher. And so if I think it's reasonable for this to be at least 30 in maturity, that's still a massive multiple contraction.

20:51And so I just can't justify it today, but then you watch it keep going up over the years. And so I'm not sure how to approach that. Sure. Sure. I've had stories like that too, where you just, it's a great business and it just always seems to trade at really difficult prices. So, I think you're not going to be able to hit all of them, right? So, some of them, you're just going to be frustrating and be like, gosh, I could have bought that five years ago and it was trading very expensive. It's still very expensive. So, yeah, everyone has their own wheelhouse too about what they feel comfortable with.

21:21And I would agree with you that probably 80 times is pretty far out there because you have to make some really optimistic assumptions for something like that to pay out. Now, of course, plenty of companies have, and you may have heard of Terry Smith, and he has done this analysis where he looks at, he goes back and says, or looks at how much you could have paid for some of these big winners. And it's always like astounding multiples, right? You could have bought L 'Oreal for 150 times earnings or something and still made 10 % annualized because it did so well. And I've done that with some of my holdings too.

21:52You just roll it back 10 years and say, well, what price earnings ratio could you have paid and still made 15 % a year. And it's always surprising. It's always a surprisingly high number. So this is just as investors, it's difficult when we have to balance out this view. You want to try to be realistic about what a great business can achieve. And at the same time, you don't want to overpay because it's painful. As you mentioned, if you pay something 80 times something and then it goes to 30 over the next two years, that's a painful and harsh headwind to overcome. So. Have you seen the companies you study revert, these high growth companies revert to an industry average multiple over time?

22:30Can we kind of estimate that as the potential contraction or is that not the right way to think about it? No, I don't think so. Well, I mean, I think that these big winners that we're talking about often are able to resist those mean reversion trends for a very, very long period of time. So I would say it's pretty common for 100 baggers in the study to trade at large premiums to the market. It's not like they were a secret. So yeah, I think you'll wind up paying a premium sometimes and that's okay because it will always, as you say, it will hold its multiple for quite a long time and it will grow into it and you'll still do very well.

23:03So there's not any hard and fast rules here. I think it's kind of a case by case. But in general, I would definitely feel safe with the conclusion that many of these stocks traded expensive for good chunks of their history. How do you think about unprofitable companies or do those just not even make it to your list? Because a lot of small companies these days, it seems, aren't profitable and you kind of have to make a bet on their future growth and their future profitability. So how do you think about these unprofitable companies? Yeah. I mean, this is where I think, again, it's maybe more of a personal preference what you can do here.

23:38But for me, it's a basic filter. They have to be making money, have to be profitable, and I have to see the good returns now. I'm not some sort of a money loser now that maybe five years from now, we'll turn the corner. I think it's less risky to focus on companies that are profitable. But as you mentioned, there are certainly lots of companies that were unprofitable at first. And if you were correct, you really got paid pretty well. Are there any adjustments that you make to maybe compare apples to apples better with unprofitable companies versus profitable companies or even technology companies or healthcare or anything like that?