INVESTORS who talk about ‘tenbaggers’ – stocks in which you make 10 times your money - are looked at with scepticism: they’re either trying to write a book or sign people up for a newsletter that promises untold riches.
But investors who talk about tenbaggers in Europe are looked at with bemusement: they’re clearly delusional.
This is a pity, because exploiting asymmetry in the market, where we take advantage of stocks with unlimited upside but limited downside, is one of the biggest drivers of successful investing. You might think this is simple common sense - find the big winners and hold onto them for a long time – but if it’s that straightforward, why aren’t more managers doing it?
Short-termism and pessimism are partly to blame, and most investors find it incredibly difficult to hang on to a winner once they’ve found it. Yet a small number of big winners are responsible for driving overall performance
The importance of big winners on portfolio performance was identified in Hendrik Bessembinder’s paper ‘Do Stocks Outperform Treasury Bills?’. His conclusion that “the entire gain in the US stock market since 1926 is attributable to the best-performing four per cent of listed stocks” shows that it’s not how often you’re right, but how much money you make when you are.
The probability of finding a big winner in Europe is better than you might think. We examined the distribution of 10-year rolling returns over the past 30 years in various regional markets and found the chance of finding one was roughly the same anywhere. By analysing data going back to 1988, we identified every European company with a market capitalisation of at least $750 million in today’s money that rose more than 10 times within a decade. We found 73, and there are some interesting observations.
For example, a range of growth rates can result in spectacular performance. The ability of companies to expand returns through economies of scale, innovation and pricing power is no surprise, but almost two thirds of tenbagger companies grew sales between only 5% and 15% over the 10-year period. It’s a misconception that they need to be growing at 15%, 20% or 30% to be outliers.
Almost two thirds of the big winners were also in the bottom two quintiles when it comes to market capitalisation. Most of the innovation in Europe is being driven by smaller companies that have much more entrepreneurial cultures and nimble organisations, which also coincides with barriers to entry falling in many large industries.
Europe is also home to many industrial companies that we would consider hidden champions. These are niche B2B businesses that dominate industrial markets – Kone in elevators, Geberit in toilet plumbing, or Atlas Copco in air compressors – and generate customer loyalty through their high-quality and innovative products. They also tend to be the natural consolidators of fragmented markets but, most important of all, have shown time and again that they are misunderstood and mispriced by most investors.
Finally, about 75% of big winners had founders, families or other insiders with ‘skin in the game’ who were in many cases involved in management.
This leads to longer-term investment horizons, more conservative balance sheets and better alignment between the company and shareholders, as well as a special culture of ambition and innovation. This is much more intangible but over long periods of time may just be the most important factor driving ultimate success.
There hasn’t been much to cheer about in Europe over the past decade and more recently focus has been on Brexit, slowing growth and other geopolitical concerns. No doubt these will have profound effects on our lives, but they only really serve to get in the way of actual investing.
Europe will continue to be a fantastic region to find companies with the potential to benefit society and generate huge returns.
Stephen Paice is a fund manager at Baillie Gifford.
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