The Characteristics of Five-Year Tenbaggers

A “tenbagger” is a stock in which you make ten times your initial investment. As Peter Lynch wrote in One Up on Wall Street, “a tenbagger is the fiscal equivalent of two home runs and a double.” Of course, it could take a long time to make back ten times your investment—if you take a long view, the S&P 500 is a tenbagger. So I’m going to focus in this article on five-year tenbaggers: stocks whose five-year return (including dividends and splits) is over 900%. Today, for example, if you have been holding any of these stocks for five years, you’ve made ten times your money: Abiomed, Codexis, Educational Development, EnviroStar, GTT Communications, GW Pharmaceuticals, Heska, Intricon, MGP Ingredients, Neurocrine Biosciences, Natural Health Trends, Nvidia, Siebert Financial, TAL Education Group, Texas Pacific Land Trust, and World Wrestling Entertainment. OK, you’ve probably only heard of a few of these amazing stocks. But a lot of the most famous companies of the last two decades were five-year tenbaggers at one point, including Tesla, Netflix, Domino’s Pizza, Avis Budget Group, DSW, Pilgrim’s Pride, Tenneco, Dana, Starz, Keurig Dr Pepper, Baidu, Questcor Pharmaceuticals, NutriSystem, Publix Supermarkets, Monster Beverage, ArcelorMittal, Apple, NetEase, BlackBerry, Urban Outfitters, Bally Technologies, and Chico’s FAS.

I was curious about what qualities tenbaggers generally had back before their price rose ten times. So I set up a little experiment. Using Portfolio123, I identified companies whose price (adjusted for dividends and splits) was ten times what it was five years ago so long as that price five years ago was greater than fifty cents, and did so repeatedly, going back from now to the 1999–2004 period. I then fed the list I generated into a ranking system with over 120 different factors on each inception date (five years prior to the stock achieving the ten-times price). I could now see what factors these stocks had in common.

The first thing I noticed was how few of these stocks had positive earnings: only 15% of them. The second thing I noticed was how strong their downward momentum had been. These are stocks whose median rank out of all stocks in terms of one-year total return is only 30. One momentum measure I like to look at is how well a stock compares to its 52-week high one month ago. By that measure, the median rank of these stocks is only 25. These stocks are not only losing money, but their price is cratering.

Because of their nonexistent earnings, most measures of these companies’ potential are worthless. Return on equity, profit margin, and earnings yield are all negative. And these companies aren’t evincing much hope either. If you look at those stocks that had analyst coverage, their average projected profit margin for the next year (projected EPS divided by projected sales per share) was in the 23rd percentile.

Warren Buffett likes to look at a company’s growth in terms of book value. By that standard, these companies are doing quite badly: the median book value growth is in the 41st percentile. In other words, these stocks are not only losing money, they’re either increasing their debt, decreasing their assets, or both. That’s the worst growth metric for these companies, but there aren’t really any good ones.

In terms of quality, there’s not much to say about these companies that I haven’t already said, except for one measure: income stability. This measure looks at the variability of annual operating income, with lower numbers being better. On that measure, these companies are pretty miserable—their income, negative as it is, is significantly less stable than that of the average company.

If earnings, quality, and growth are somewhat hopeless for these stocks, they do measure highly in terms of size (the smaller, the better) and value. The median price of a tenbagger is in the 28th percentile, and its size, in terms of market cap, is in the 32nd (and that’s out of all stocks, including penny and OTC stocks, that are on Compustat’s radar). These stocks are good buys if you use almost any value-based ratio (except for P/E)—price to book, price to sales, price to working capital, EV to EBITDA, EV to gross profit, EV to long-term debt, EV to sales, and a handful of other measures. Sales is the best indicator of value here: the median price-to-sales ratio of a future tenbagger is in the 76th percentile of that company’s industry.

Tenbaggers do tend to be concentrated in certain sectors. Health care, consumer discretionary, and technology stocks make up the largest percentage of tenbaggers, while the number of telecom, utility, and staples tenbaggers is pretty negligible. But then again, there have been a lot more companies overall in those first three sectors than in the last three.

Unfortunately, I have not found anything actionable when it comes to these stocks. Let’s say you used an algorithmic approach. You limit your universe to stocks with no earnings. You use a multifactor ranking system to rank these stocks in terms of all these factors: low book value growth, high income variability, low price performance, high value ratios, etc. What are the five-year results of buying stocks like these? Absolutely dismal. If you invested in the top 100 stocks according to such a system and held them for five years, starting every month from January 1999 to September 2013 (five years ago), your median annualized return for each five-year holding period would be four percentage points lower than if you’d invested in an index fund, with far worse drawdowns. And that’s with the benefit of hindsight, since there’s no way you would have known eighteen years ago the typical characteristics of a tenbagger over the last eighteen years (which are quite different from the stocks that Peter Lynch was looking for back in 1989, when he wrote One Up on Wall Street, probably the first book to glamorize tenbaggers).

I’m not a discretionary stock-picker. I leave that to others. No doubt some folks are very skilled at it. I never hold a stock for five years. Heck, I rarely hold a stock for one year. I have only two things in common with a tenbagger hunter: a passion for cheap microcaps, and a burning desire to beat the market.

But there is something I can take away from this study. The stocks with the most potential are usually found among the stocks with the least potential. If you want a diamond, you have to sift through a lot of dirt.

CAGR since 1/1/16: 50%.

My top ten holdings right now: LFVN, AUDC, PDEX, OSIR, PCOM, PERI, RLGT, NAII, GVP, AVNW.

Comments

[Jay]

I've read your blog with interest over the past few days. Excellent analysis, and writing! Thank you for sharing.
I found this post interesting. Who are these 'discretionary' skilled 10-bagger hunters? I've worked in the industry awhile and I've yet to hear of a skilled small-cap investor who makes 50%+ returns consistently (which is required for a 10-bagger in 5 years, as you've defined). I'd sincerely like to know, as maybe we can learn something from them. Have you read Phelp's book 100-to-1? I wonder if there's valuable lessons there that can be empirically tested?

[Yuval Taylor]

Thanks for your compliments!

I haven't read Phelps's book, I'm afraid. But I worry that looking for ten-baggers or hundred-baggers may be a rather poor investment strategy (a message that may have been implicit in my post). Too often would-be investors focus on what they can learn from past winners without looking at the thousands of losers that they might have chosen instead at the time. The best way to develop a winning strategy is to look at the market as a whole and figure out which stocks are most likely to appreciate, not to cherry-pick winning stocks without considering what they have in common with the losers.