How to find the next 100 bagger

Buy Hold Sell

Livewire Markets

100 baggers are few and far between. The stories of these stocks' success inspire investors' the world over, and keep them coming back to uncover the rare gems of the market time and time again. 

These exponential growth stocks can return $100 for every $1 invested, turning a $1000 investment into $100,000, a $10,000 investment into $1 million or a $100,000 investment into $10 million. 

Afterpay, for example, was listed on the ASX in May 2016 for $1.00 per share. Just over four years later, and the buy-now-pay-later darling hit 100 bagger status. 

This quick trip to the "moon" is actually quite rare. In fact, Christopher Mayer, author of 100 Baggers: Stocks that Return 100-to-1 and How to Find Them, found that it can take an average of 26 years for a stock to become a 100-bagger - meaning, these investments can make you rich over the long term, but they are certainly not a "get rich quick" scheme. 

So in this thematic episode of Buy Hold Sell, Livewire's Ally Selby is joined by Frazis Capital's Michael Frazis and Holon Global Investments' Heath Behncke for their insight into finding exponential growth stocks. 

We discuss the metrics they use to analyse the global universe of opportunities, three essential characteristics of 100 baggers, as well as their highest conviction holdings right now.  

Note: This episode was filmed on Wednesday 29th September 2021. You can watch, listen or read an edited transcript below.


Edited Transcript 

Ally Selby: Hello and welcome to Livewire's Buy Hold Sell. I'm Ally Selby, and today for this thematic episode, we'll be taking a trip to the moon in the search of the next 100-bagger. My co-pilots today are Heath Behncke from Holon and Michael Frazis from Frazis Capital. Plus we've also asked our fundies to shoot for the stars and share their highest conviction holding right now.

Michael, I might start on you. With valuations where they are right now, are you finding it difficult to find global growth opportunities?

Michael Frazis: Look, I think there's a pretty compelling opportunity set at the moment. Everything's just moving so fast these days, people can spin up companies and they can become global leaders within a few short years. So, it always seems to be a new breed of companies trying to really achieve great things. More recently, there's been a bit of a shakeout in markets. So, interest rates started rising, the NASDAQ was down nearly 3% last night, and a lot of the most favoured growth stocks, particularly in the software sector were down 5% and in some cases more. So, there are definitely opportunities out there if you know where to look.

Ally Selby: Heath, same question to you. And are you using recent weakness as a buying opportunity?

Heath Behncke: We definitely have, Ally. As Michael's indicating, we've seen that rotation that's happened this year as things started to actually open up, as a great opportunity to take advantage of some of the (sell-offs) that we see. Particularly, post-COVID where people underestimate some of the change that's coming as a result of those behavioural changes in the way people operate on an ongoing basis. There are some great opportunities that are popping up in otherwise what is a very, very low growth world - if anything, no growth, in many ways.

Ally Selby: Heath, I'd love to know what metrics you use to find and analyse global growth opportunities and how these differ from traditional metrics? 

Heath Behncke: The main thing that we're always looking for is a very strong value proposition. There are very well-founded metrics that you can actually utilise: customer lifetime value, customer acquisition costs, revenue, price to sales and other models that really matter. But eventually, like with everything we look at, we're looking at profitability. You have to get propositions that will be sound financially from that perspective. 

What a lot of what people misunderstand, is that many (of the companies) that we look at could be highly profitable today. They're just scaling at a very, very rapid rate. And that's the thing. Once you start to really understand that dynamic in this era of cloud and smartphones, then you start to look at things differently.

Ally Selby: Michael, same question to you. We've spoken about the metrics that you used before. Could you take us through them?

Michael Frazis: It might be better to think about the metrics that we don't use, or that can be very misleading and difficult to be able to interpret. So one of those would be, for example, free cash flow. And this is purely in the high growth tech and biotech kind of place that we play in. And the reason for that is, the best companies in the world that are growing really fast, have the best growth opportunities; could open up new offices, launch new products and get tremendous amounts of sales and increase in size at rapid rates. They'll hire salespeople, they'll spend on R&D. They do all these kinds of exciting things, and often they'll manage their free cash flow to zero. 

And so when you think about metrics, I think it's interesting that if you use free cash flow, which most people will start at, you immediately rule out almost all of the companies with the best investment opportunities that can really hire a small group of people and achieve great things.

So, in terms of what you would use instead, you can measure the return on that investment, on the return on hiring a sales team, on spending on acquisition costs. As Heath said, lifetime value, all those kinds of things. These are very good ways to assess fundamental profitability before that. But ultimately what we really look for is also execution and delivering on the top line. So, could you add users? Are users spending more and more? Are your revenues growing at a rapid rate? And often that's a good place to start when assessing opportunities, particularly high returning opportunities.

Ally Selby: If you had to choose three essential characteristics of explosive growth stocks, what would they be?

Michael Frazis: We like to start with the customer, so it would be true customer love. The second thing is we to see the results come through and we try not to have opinions. We want to see companies growing really fast. So the second thing we look for is explosive revenue growth. 

And the third thing we'll look for, which is the most challenging and where the art is, rather than the science, is to assess their return on investment. And in fast-growing companies, often the investment is not in capital, it's not in factories, they're not buying buildings, they're investing in people, they're paying out salaries and bonuses. 

And calculating the return on that is non-trivial. But the companies that do best are the ones that get the highest return on that. So, the third thing we look for is an extremely high return on investment.

Ally Selby: Okay, same question to you, Heath. What are three characteristics of global growth opportunities?

Heath Behncke: So, for the first one, Ally, is a very simple and strong value proposition, one that is very clear to all stakeholders in the ecosystem. The second one is scalability - the transferability of that globally. And the third one is the founder and the management team. 

Who is actually on the bus? That's very, very critical. So, get the right people on the bus, you'll solve all the problems and execute on the opportunity. 

So, we just keep it very simple in general, and the simpler the conversation, the easier it is to scale.

Ally Selby: We've also asked you to bring along a handy tip for investors today. It's quite a big global universe out there. What is one tip that they can use to help scour that universe?

Heath Behncke: The first thing I'd say to people is: 

Pay attention to what your children are doing. That's probably the best way to start investing. And to really do it through referral. That's the way I've tended to work over my career. Actually, a lot of the (companies) I've invested in have just come through great referrals or people talking glowingly about the product or service. 

And I think that's always a good way to start, particularly to keep on top of where things are going.

Ally Selby: Michael, same question to you. What's your one tip so investors can better scour the investment universe?

Michael Frazis: I probably agree largely with Heath. Start with customers, start with the product, see what people really like. If I had to give one tip, though, it would probably be:

You're going to do best if you stay with fast-growing tech businesses that people really like. That is probably where you're going to get the most consistent, long-term returns. That's where capital is flowing. That's where revenues are flowing within industries. 

If you stay on the right side of all those shifts, and it can be as simple as buying a NASDAQ 100 ETF or equivalent Australian tech index. Give yourself the best chance of success by starting there.

Ally Selby: I know you both invest in China. With everything that we've seen going on over the last few weeks, Michael, I might start on you. Are you still investing in that region? Or are you steering clear of it?

Michael Frazis: We have some long-standing positions there. So, one of ours is Pinduoduo (NASDAQ: PDD). It's still up about four times from when we bought it. Though, obviously, it was up a lot more about six months ago. The rest of our exposure is largely Hong Kong-based. It would be naive to think that in Sydney, we can sit here and say exactly what is happening. I do think long-term, there are very good reasons why the Chinese want these companies to be strong, prosperous, and powerful, and those are important considerations.

Ally Selby: Over to you, Heath. Same question, are you still investing in China at the moment? Or are you steering clear of the region?

Heath Behncke: Absolutely. We've got a strong view that China is leading the game when it comes to technology and innovation. 

Nearly a third of our portfolio is there now. We've added to that, taking advantage of the weakness.

The world is seeing China through Western eyes, as opposed to looking through Eastern eyes. And you can see that they're balancing things out, something which probably should be done actually in some ways in the West with some of the dominance of some companies. But we think that there's just a glaring opportunity at the moment are to put money to work in businesses where valuations are not the concern.

Everybody's thinking that the Chinese are going to socialise the entire market, which we just don't think that will be the case at all. We think they're just making adjustments to the model. So, we do think there are some great opportunities actually popping up there. You need to think more long-term about the opportunities. I just don't see why China would want to reverse the position that's basically got 800 million people out of poverty.

Michael Frazis: There's obviously been a huge sell-off and horrific news flow, and all kinds of things. Interestingly, now that markets have come off and all those stocks are trading so cheap, the future returns are much higher. 

So, the risks are roughly the same. If anything, it's increasingly clear with each regulation that comes out, what the final landscape is going to look like. In many ways, you've got clearer risks, but much higher returns going forward. 

As Heath said, I think you have to be long-term if you're in a market like that. What you can't do is invest and then some news flow comes out and then you sell your stocks when they're down 30, 40, 50%. That's just going to be a loss-making proposition in any market that you do it.

I think if you invest in China, you have to be in it for at least three to five years from here. And if you think along that timeframe and ask the questions around, where should it be over three to five years? You get a very different answer to the question of what do you think's going to happen next in markets? Which of course, nobody can really answer.

Ally Selby: Well, it sounds like both of you guys are buying when there's blood in the streets. I'd love to know how you know when to add to a position or when to sell down a position. Michael, I might start on you. Is there an example of both?

Michael Frazis:
We will look at the company and see if it's growing or shrinking. So, every quarter you get a good snapshot. We try not to move too fast and trade too much. 

So, really take a look at the data. If they're adding users, they're growing, they're bigger, better, and stronger, we're much more inclined to add if it's down.

Similarly, we'll do the same thing when we sell. Often, that doesn't work. So, Xero (ASX: XRO) is an example I'll give where we sold probably too early after a company slowed down.

Xero slowed down to 30%, but all of a sudden started generating free cash flow and got a whole new set of institutional investors and the multiple doubled. So, a lot of people think that as growth slows down in these growth stocks, valuations go down. But in actuality, what we've seen in more than one instance is those valuations go up.

Ally Selby: Over to you, Heath. What are the signals that you look out for when to know to sell down a position? And on the other side of the coin, when do you know to add to your position as well?

Heath Behncke: We have a valuation on every company, Ally. And then essentially, we are really contrasting at a point in time where these companies are relative to that valuation. So you might find there's a weakness when the price is well below the valuation, we start adding, or when it starts coming up above the valuation, then we'll start selling. So, simply it's just moderated each time we continue to roll forward and update our valuations. And according we just continue to monitor the progress on an ongoing basis.

Ally Selby: Are there any examples that you could take us through quickly?

Heath Behncke: Tesla (NASDAQ: TSLA) is a great example of that, where it was substantially undervalued, it went up seven times since when we initially invested. Then of course the valuation starts getting pulled forward and realised. And then we started selling the position down. We still held it in the portfolio, but it was actually on a low weighting. And then we bought back in on weakness as well, when the company actually started trading below what we thought the valuation was. And we've done this for several other stocks over time, Afterpay, Xero and others with a very similar viewpoint where we take a view of where we think the development should be at any point in time, and then we will be pragmatic enough to actually buy or sell around those positions at the margin.

Ally Selby: Heath, we asked you to bring along your highest conviction holding today, what is it and why do you think it can become a 100-bagger?

Heath Behncke: Well, in our portfolio that has to come out of the Web 3.0 space, which is Bitcoin. So, we've got MicroStrategy (NASDAQ: MSTR) in the portfolio. Particularly post what's happened in 2020 with one of the major banking regulators in the US getting on board, the OCC. We can see that post that conversation, Visa, Mastercard, PayPal, just about all the major institutions in the world, are now getting on board solving adoption. And the question is just how much adoption is being solved? 

So, we think there's a real probability over time that this will continue to grow as the Web 3.0 ecosystem grows. It is hard to see where it's come from. A lot of people think (MicroStrategy) is (already) big. But actually, when you look at the opportunity set and what it could emerge into, it is a very, very big conversation that Bitcoin's actually solving in terms of the infrastructure for our money as we move forward to digital gold. So, we think that's actually got a hell of a lot of legs as we move forward, and would be our highest conviction bet. 

Ally Selby: Okay, Michael, same question to you. Your time in the hot seat. What's your 100-bagger stock and why?

Michael Frazis: Look, my highest conviction holding is Sea Ltd, based out of Asia, ex-China. Its company has two key businesses; it's e-commerce and gaming. It's in one of the fastest-growing parts of the world, population-wise. Also, one of the parts of the world that is increasing in income and wealth at an incredible rate. 

The interesting thing about this is, e-commerce in these parts of the world is mid-single digits, like 4%, 5%, 6% in countries like Indonesia, Taiwan, Thailand. That's a long way to go to 35%, 40%, where it is in China and even 20%, 25%, where it is in countries like Australia. 

It has a huge tailwind. You've got a really young, effectively much poorer population than other parts of the world that's growing extremely rapidly, and penetration is really low in those parts of the world as well. So, you've got these multiple compounding layers of growth.

There are other interesting parts of the story. They have a very popular game called Free Fire. It's kind of like a shooting game. It's optimised for low-end smartphones and is very popular in places like India, South America. And again, they're going to be able to use the free cash flow from having one of the most successful games ever to fund e-commerce. And we all know how powerful e-commerce can be to the market leader. Once you have that market leadership position, you generally have a wider range of goods, you can offer lower prices and you just have a better delivery network as well.

I'm kind of cheating a bit because this stock is already up about eight times since we bought it. And I don't think it'll go up a hundred times from here, but quite possibly from where it was two years ago. It's a $180 billion company. I think it's going to be one of the true global leaders. I'm really excited about it.

Ally Selby: Awesome. Well, thank you so much for your time today. It was such a pleasure to speak to you both. If you enjoyed this episode of Buy, Hold, Sell, why not give it a like. And subscribe to our YouTube channel. We're adding new content every week.

What stock do you think can become the next 100 bagger? 

Heath's highest conviction holding is MicroStrategy, while Michael is backing Sea. But we would love to know what stock you think can become the next 100 bagger (or close to it). Let us know in the comments section below. 

Can't get enough of Buy Hold Sell?

Give this wire a like if you've enjoyed the discussion and hit follow to be notified when new episodes are released.

If you're not an existing Livewire subscriber you can sign up to get free access to investment ideas and strategies from Australia's leading investors.

........
DISCLAIMER Livewire gives readers access to information and educational content provided by financial services professionals and companies (“Livewire Contributors”). Livewire does not operate under an Australian financial services licence and relies on the exemption available under section 911A(2)(eb) of the Corporations Act 2001 (Cth) in respect of any advice given. Any advice on this site is general in nature and does not take into consideration your objectives, financial situation or needs. Before making a decision please consider these and any relevant Product Disclosure Statement. Livewire has commercial relationships with some Livewire Contributors.

3 contributors mentioned

Buy Hold Sell is a weekly video series exclusive to Livewire. In each episode two fund managers give their views 'Buy, Hold or Sell' on five ASX listed companies. Not recommendations, please read the disclaimer and seek advice where appropriate.

I would like to

Only to be used for sending genuine email enquiries to the Contributor. Livewire Markets Pty Ltd reserves its right to take any legal or other appropriate action in relation to misuse of this service.

Personal Information Collection Statement
Your personal information will be passed to the Contributor and/or its authorised service provider to assist the Contributor to contact you about your investment enquiry. They are required not to use your information for any other purpose. Our privacy policy explains how we store personal information and how you may access, correct or complain about the handling of personal information.