In our blog series, Books That Inspire Us, we share our favorite book titles, why we like them, what we learned from them, and how they inspire the work we do here at Evolutionary Tree Capital Management.
In this blog post, Evolutionary Tree Senior Research Analyst Jonathon Ansley, CFA, reviews 100 Baggers: Stocks that Return 100-to-1 and How to Find Them. In this book, author Christopher Mayer studies the historical patterns and key characteristics of companies that have driven outstanding long-term stock returns—a rare event, but one worth exploring.
JA: Author Christopher Mayer’s inspiration for writing 100 Baggers was Thomas Phelps’ book 100 to 1 in the Stock Market, a study of companies that returned one hundredfold through buy-and-hold investing. Originally published in 1972, Phelps’ book includes stock price data from 1932 to 1971. In 100 Baggers, Mayer picks up where Phelps left off, updating the original analysis with stock price data from 1962 to 2014. In total, Mayer identified more than 350 additional 100-baggers over this time period and provides insight into the common characteristics of these companies.
JA: There are several important lessons in this book that relate to elements embedded within Evolutionary Tree’s eight investment criteria, such as time horizon, quality, management, and competitive advantage. To some investors, these may seem like simple concepts, but Mayer has structured the book in a powerful way that helps investors understand how these elements fit together and could potentially lead them to businesses that can compound wealth.
At Evolutionary Tree, we’re not specifically looking for 100 baggers, which often need to have smaller market capitalizations to make the math work. The companies in our investment pool generally have market caps greater than $1 billion. But many of the characteristics exemplified by the 100 baggers in Mayer’s research are things we at Evolutionary Tree also look for. For example, we focus on high-quality growth stocks with next-generation products or services that have competitive advantages and strong management teams. Also, we aim to identify emerging innovators earlier on the industry lifecycle and hold those stocks over a long-term horizon, which can allow for the potential to drive multi-bagger returns.
JA: Mayer wrote about the importance of not getting distracted by the day-to-day movements of stock prices and holding onto stocks for a long-term horizon of 10 years or more, a concept sometimes referred to as the “coffee can portfolio.”
Coined by Robert Kirby, a professional portfolio manager whose career took off in the 1970s and ‘80s, the phrase, coffee can portfolio, “harkens back to the Old West, when people put their valuable possessions in a coffee can and kept it under the mattress. The success of the program depended entirely on the foresight used to select the objects to be placed in the coffee can to begin with.”
Mayer emphasizes that doing the necessary research to find companies in which investors have long-term conviction and therefore hold for a longer period is especially important during market and economic downturns and is the key to finding a true 100 bagger. I believe, now more than ever, it’s hard for investors not to let market volatility get the best of them, particularly when so much of today’s market commentary focuses on macroeconomic events like Fed policy and inflation. Sticking with investments in quality companies is critical and requires looking beyond the next few quarters. Owning truly innovative companies—those creating new products and services—helps build conviction to stay invested long term.
JA: Mayer explains that almost all of the businesses in the study that became 100-baggers were substantially bigger businesses at the end than when they started. In short, it was the growth companies, which could compound revenue and earnings per share over many years, that ultimately made it to 100-bagger status. But he adds that the quality of the growth matters, and it must be sustainable. He writes:
At Evolutionary Tree, we designed our investment philosophy to focus solely on the future drivers of growth. What matters is understanding the root cause of future growth in revenue and earnings, which we believe is innovation. You don’t get rewarded for past growth. We search for companies with significantly better products or services that are driving a next-generation offering within an industry. These are the companies that interest us the most as potential new investments.
Another critical characteristic of multi-baggers is the presence of competitive advantages, which in turn, are key support for sustaining leadership, margins, and returns. In today's economy, we believe leading companies need layers of competitive advantages, not just one. This is a key element of our eight investment criteria. Companies that can combine multiple competitive advantages, such as brand, scale, network effects, and distribution advantages, can generate wide moats around their business.
JA: It is becoming more difficult to find stocks that you can hold for decades, and therefore more difficult to find 100 baggers. This is evidenced by the average company lifespan in the S&P 500 Index, which has gone from a 61-year average in 1958 to less than 20 years today with projections for a further decrease. Contributing to this trend is the accelerating change that’s occurring in what we at Evolutionary Tree call the Age of Innovation. In my view, this dynamic underscores the importance of finding a manager that can help investors navigate an evolving economy and accelerating shifts and trends.
I believe it’s important for investment managers to focus on understanding how different sectors and industries evolve so they can position the portfolio to benefit from the next generation, while simultaneously avoiding the old generation that may be negatively impacted by innovation. At Evolutionary Tree, we have developed an investment philosophy and process we believe can specifically benefit from all the change we’re seeing across industries, sectors, and the economy.