Business News Asia
Before we get into the topic, we should first acknowledge Peter Lynch who brought the term “tenbagger” into the world and is one of the most brilliant minds in the financial world.
A tenbagger is a stock that has increased its share price more than tenfold.
Investors and speculators are always looking for value in the market, more importantly, undervalued companies. The joy of the rise in the price of a share pleases every investor because price gains are the main goal of stock investments. I will probably never forget the feeling when the first time the price of an investment had only doubled.
Investing, however, is not about being right all the time, but rather about being right more often than wrong. Let’s say you invest $100 in a stock. The stock is a flop and the company dissolves into dust. That means you lost $100. On the other hand, what happens if your $100 investment increases tenfold? Then you have made $1000.
If you invest in 3 stocks and 2 of them turn out to be losers then you lost $200. The 3rd stock increases tenfold. That means you took in $1000 in stock gains, minus $200 lost equals a final amount of $800 in your pocket. Of course, in the real world, you still have to consider taxes and broker fees. Still, you would end up with a significant profit.
Note: We are not encouraging anyone to invest in risky stocks, nor is this financial advice.
Investing in equities usually takes a lot of time for research and calculations to understand the business, its industry as well as to determine the financial situation.
Ultimately, it is important to determine if the company and its business model can grow in the future, and probably most importantly, that the share price is cheap. Undervalued high-quality businesses are probably the kind of investments that professional investors look for, as no one wants to buy overvalued stocks.
If a successful business manages to increase its earnings, the share price will follow sooner or later.
Here I would like to introduce two key metrics that are uncommon for new investors but important in the investment world.
One is the p/e ratio and the other is market capitalization or market cap for short.
The p/e ratio is the comparison of price to earnings per share. If the p/e ratio is high, it means that the price of a stock is high compared to the earnings per share of a company. Conversely, if the p/e ratio is low, it means that the price is low compared to the earnings per share of the company. The market cap is calculated by multiplying the numbers of shares outstanding by the current price of the share.
The point at which a share is considered too expensive or cheap depends on the industry and the company. You should understand that when you calculate the p/e ratio, it is a snapshot based on the last earnings. Earnings are reported in the quarterly or annual report. If you want to calculate the forward p/e ratio you would have to predict the future earnings. This can turn out good or bad. But I would argue that Company A with a p/e ratio of 4 sounds far more attractive to me than Company B with a p/e ratio of 100.
So if you are evaluating a company and you think that the share price will increase tenfold, try to look at it from the following perspective.
Whenever you invest in a company, you want its market cap to rise. This happens when someone wants to pay more for the stock which means that your stock becomes more valuable. So the question is how much does the company need to earn to support a tenfold increase in share price?
Let’s say the company is called Natural Corp. with a stock price of $1 and 100 million shares outstanding. The market cap of Natural Corp. is then $100 million. You now believe that the share price of Natural Corp. will increase tenfold, meaning the price will go to $10. This would mean that Natural Corp.’s market cap would increase to $1 billion.
Assuming that Natural Corp. is growing rapidly with a p/e ratio of 50, Natural Corp. would have to earn $20 million per year to support a $1 billion market cap. When you study the industry and the company and compare it to Natural Corp’s competitors, you have to evaluate whether that seems possible.
Why you choose to invest in a specific company will have its reasons. However, you should not only look at the current price of a share, because the price alone does not give you any information about the company, its industry, and its financial situation. The price also does not tell you whether the stock is overvalued or undervalued. So be careful when looking at the price alone.
The goal however should always be to increase the value of your investment.