Ahh, the mystical 10-bagger. A stock that has delivered its investors a 10x return on their initial investment. Initially coined by legendary investor Peter Lynch, who was a fan of discovering undervalued stocks with sustainable and attractive earnings per share growth, a love of 10-baggers saw Lynch’s Magellan Fund achieve a 29.2% average return over the 13 years he managed it.
In his book, One Up on Wall Street, Lynch wrote, “In my business a four-bagger is nice, but a ten-bagger is the fiscal equivalent of two home runs and a double.”
While this anonymous writer may not know anything about sports, I do know a few talented local fund managers who can help investors identify the ASX’s next great 10-baggers.
So, in this episode, Livewire’s Ally Selby was joined by Ausbil’s Andrew Peros and Ellerston’s David Keelan. They share their secrets to identifying long-term compounders, the importance of backing strong founders, the red flags investors should look out for, and whether profitless companies are a problem or worth the risk.
Plus, they each name a company that they believe could become the ASX’s next 10-bagger.
Note: This episode of Buy Hold Sell was recorded on Wednesday 20 November 2024. You can watch the video, listen to the podcast 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 we’re taking a deep dive into the spicy end of the market, and by that I mean small and micro caps. To learn how you can find the next great compounder and maybe even a 10-bagger, we’re joined by Andrew Peros from Ausbil and David Keelan from Ellerston.
Andrew, I’m going to start with you today. We’ve obviously had quite a few awesome 10-baggers on the ASX like Afterpay (now Block ASX: SQ2), Fortescue (ASX: FMG), REA Group (ASX: REA), CSL (ASX: CSL), and Telix (ASX: TLX), to name a few. There’s obviously been more. Is there anything that they all have in common?
What ASX 10-baggers have in common
Andrew Peros: I’ll start by saying a few others that have been notable 10-baggers. HUB24 (ASX: HUB), Life360 (ASX: 360), and Pro Medicus (ASX: PME) – all very well-known names in the small and micro caps space that have graduated to become successful small and mid-caps. I would say the most common theme that I’ve noticed is that they’re pioneers or disruptors in their field of business. Afterpay, for example, was a real pioneer in that buy now, pay later space, REA Group took advertising into the digital realm, and then Life360 really in that family safety and family tracking part of the market. It’s a new category and they’ve been quite successful on that front. A lot of them are founder-led, a key theme in smaller micro-cap space, have scalable business models using existing technology and scale it out into the global market.Ally Selby: Do you agree? Do they have to be first-mover businesses as well?
David Keelan: No. First of all, if there’s going to be a lousy Total Addressable Market (TAM) or if there’s not a lot of TAM, there’s no point. Generally, they have a twist on the traditional model, so therefore, they’re easy to accept. So, they are not fully disrupting, but have a different edge on what’s out there already and a strong call to action.
How to identify long-term compounders
Ally Selby: What’s the secret to identifying long-term compounders then? Are there any factors that you think are really important?
David Keelan: In our space, we back the jockey, so it has to have a really strong founder or owner of a business, someone that is very singular-focused. Generally, in the smaller end of the market, these companies have one vertical. They do one thing well. They’re not a conglomerate. They’ve got one stream and they’ve got to be really focused on this. So, a strong founder, strong focus, and understands capital management – when and where to use it.
Ally Selby: Okay, over to you. Which factors are important to you, Andrew?
Andrew Peros: Well, I certainly agree with David. Founder-led businesses have a history of delivering through time. We have approximately 40% of our portfolio in founder-led businesses. So, we really do back the man. But one thing that we do at Ausbil is we screen out the unprofitable and illiquid names first. They are the concept stocks, the stocks where you can’t really assess future earnings. There’s perhaps no prospect of profitability. So, once we screen those out, we look for companies that are on that journey to profitability and hopefully capture them early in their life cycle.Ally Selby: So there are no zombies in your portfolio?
Andrew Peros: Absolutely not.Ally Selby: What are some red flags investors should be aware of other than profitless companies?
Insider selling is the biggest red flag
Andrew Peros: Red flags are very easy to see in hindsight, but for me, the ultimate red flag is insider selling. It’s not always an issue if an insider is selling down a small portion of their shareholding, but if they’re selling a large proportion of their shares in one hit, you need to ask questions. For us, it’s a red flag. And I guess the greatest example I can give you is a2 Milk (ASX: A2M). After the August result in 2020, you had the CEO, the Chairman, the head of APAC, and the head of marketing, all selling a substantial chunk of their shareholding for “tax purposes”. But what transpired after that was four consecutive profit downgrades over a period of nine months. So that’s clearly the biggest red flag for us.
Ally Selby: How do you feel about the Life360 sell-down that we’ve seen recently?
Andrew Peros: It was well flagged. Chris Hulls is a very energised and motivated founder. He still has plenty of skin in the game. We did get notice of a potential sell-down coming 12 months ago, so it shouldn’t come as a surprise to investors. But for what it’s worth, the volatility in the share price we have seen as a buying opportunity. So, it’s been great for us.Ally Selby: Okay. Over to you, David. What red flags do you think investors should be aware of when investing in micro-cap stocks?
David Keelan: I agree with Andrew. Insider selling – follow the smart money instead of dumb money. Ellerston is an active manager. We like to travel for a third of the year. We love speaking to management and industry contacts. We’re looking for a change in narrative. When things change and we can’t articulate why, that’s a red flag to us.
Should you invest in company’s without profits?
Ally Selby: Andrew said before that he doesn’t like to invest in profitless companies. Do you agree? Do you invest in companies without profits?
David Keelan: We invest in companies that will have negative free cash flow. Our view is that at this end of the market, it’s part of our job. We spend a lot of time with these companies trying to understand their unit economics. We look to offshore peers to see how they’re articulated. Aussie companies are a bit more immature in how they present sometimes. So we’ll spend time with management, spend time with the CFO, and really try and understand what return they’re going to get back on their investor capital.Ally Selby: Is the profitless company rule hard and fast, or do you sometimes invest in companies without profits?
Andrew Peros: We’re not punitive when thinking about profitless companies. We do make exceptions. I mean, how else would we have invested in Afterpay and Life360 in the early part of their journey? But generally, we want to see that path to profitability within a 12-month period. As a minimum, we want to see cash flow break-even just so we know that they’re self-funding and they can fund their growth sustainably. So that’s a way for us to de-risk the proposition.Ally Selby: Okay. We asked our guests to bring along a stock that they believe could become the ASX’s next 10-bagger. David, what have you brought for us?
2 stocks that could become the ASX’s next 10-baggers
Veem (ASX: VEE)
David Keelan: So, I’m going to name one that’s just downgraded. We’ve got a small position in Veem. We think Veem has the potential to be the next PWR (ASX: PWH). Veem’s core business makes gyros, which stabilise ships and boats, and they’re growing into propellers, shaft lines, and defence. The market got really ahead of itself over the last 12 months, with stock trading at $2. It is now around $1.20. It will drift for a while while the market re-calibrates its expectations, but we think over the next three to five years, it’s got amazing upside.Ally Selby: Okay, over to you Andrew. Which stock do you think will be the next ASX 10-bagger?
Catapult Group (ASX: CAT)
Andrew Peros: Today, I’m going to name a company called Catapult, ticker is CAT, which operates in the world of sports analytics and data aggregation. Now, the starting point from my perspective with CAT is sport is a very big business. Some of the largest sporting teams in the world are worth tens of billions of dollars. There are hundreds of billions of dollars spent on advertising, TV rights, and affiliate programs. So there’s a huge share of wallet that these sports teams are targeting. Now, the opportunity for CAT is to leverage their products, become part of the fabric for these elite sports teams, so it can give them the edge when it comes to competition and winning competitions.
As I said, it’s big business. There’s big money involved, and the price of a CAT product is only a very small proportion of the overall sports spend. So, I can see a path for CAT to generate roughly US$800-$900 million over the next five to 10 years. You put that on a reasonable EV to sales multiple, add a discount to some of the other SaaS companies in the market, and you can easily see this being a 10-bagger, if not a 15-bagger.
Ally Selby: Wow. What an awesome way to end the episode. I hope you enjoyed that as much as I did. If you did, why not give it a like? Remember to subscribe to our YouTube and podcast channels. We’re adding so much great content just like this every single week.