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Ten-baggers are mostly used to describe stocks that grow ten-fold within a given time frame. For an investor to benefit from a 10-bagger, they usually must stick with the investment for a long time.
The term “10-bagger” was actually popularised by legendary investor Peter Lynch, which he borrowed from baseball where additional base hits are referred to as “baggers”.
Surprise, surprise! A 10-bagger in just three years
I bought a Canadian based company – Shopify Inc (TSX: SHOP) (NYSE: SHOP) at US$90.60 in July 2017 through the New York Stock Exchange.
I scored my first 10-bagger threshold when it reached US$909.8 on 22 June 2020. It’s now the single largest stock accounting for 16% of market value in my portfolio.
The most critical reason I bought because Shopify is because it’s a category killer that has a unique business model and simply dominates the field it operates in.
As The Motley Fool’s co-founder, David Gardner, is fond of saying, “there’s no Pepsi to their Coke”. In other words, there’s no real competitor to Shopify.
Shopify’s e-commerce platform allows merchants of all sizes to build an online presence, including storefronts and fulfillment, payment, and shipping services.
The plug-and-play interface is intuitive and easy to master, making it easier than you think to start selling online. E-commerce has become a necessity, not just a convenience, and Shopify is the go-to provider for e-commerce shop-building.
Companies want to build their own brands instead of hitching a ride as a third-party supplier on the tailcoats of Amazon.com Inc (NASDAQ: AMZN) or somewhere else. It’s that entrepreneurial spirit that will keep driving merchants and shoppers alike to Shopify.
Great companies are rarely cheap
Shopify first traded at US$17 in May 2015 in the US market. I was two years and two months late to join the party buying at a price that was 530% higher. However, Shopify has always been considered grossly overvalued from day one, according to most financial media.
On the contrary, the “expensive” label has been meaningless as the company has continually smashed analyst earnings’ consensus expectations over the years.
It just becomes more apparent that most investors are underestimating the growth potential of Shopify’s business. The most successful companies are the ones that will break your financial models anyway!
I seek out companies, like Shopify, that have sustainable advantages gained through business momentum, visionary leadership, and inept competitors. Its premium valuation comes from remarkable revenue and cash flow growth.
For instance, an apartment in Taikoo Shing is always more expensive than the same size flat in Tuen Mun. Legendary investor Warren Buffett once said:
“It’s better to buy a wonderful company at a fair price than a fair company at a wonderful price.”
Focus on cash flows instead of earnings
In theory, the valuation of a company derives from all future cash flows discounted to today. Yet earnings are subjected to accounting assumptions such as depreciation.
Under the new economy, many growth stocks intentionally report losses by re-investing most operating profits into their business in the form of working capital and capital expenditures for future growth.
You deem to pass up many opportunities to invest in great stocks like Shopify if you focus only on traditional valuation metrics such as price-to-earnings (PE) multiples where you rely solely on earnings to value stocks.
In Amazon’s 2004 Annual Shareholder Letter, founder and CEO Jeff Bezos provided a great lesson for investors on the importance of focusing on free cash flow:
“Our ultimate financial measure, and the one we most want to drive over the long-term, is free cash flow per share.”
Investors should, therefore, pay more attention to the growth rate of revenue and free cash flow rather than the earnings of your invested companies.
Don’t panic when shares drop
Great companies aren’t immune to market crashes! Shopify dropped sharply from US$593.9 in mid-February to US$305.3 in late March due to the pandemic, a correction of nearly 50%.
Panic selling is often people’s first reaction when stocks are going down, leading to a drastic drop in the value of their hard-earned funds.
It’s important to know your risk tolerance and diversify your portfolio by investing in different sectors and stocks. At The Motley Fool, we recommend owning 20 or more stocks in your portfolio.
Stocks do indeed fall sometimes dramatically, but they do also recover. Stocks are volatile in the short term, but over the long term, returns are far more positive than negative.
Act like an owner of your businesses, not a trader of them. We don’t trade tickers; we invest in companies – great companies with business models that we believe are transforming their industries and making a difference in the world.
Don’t sell winners too early. Enjoy the ride
Worst-case scenario, a stock can only lose 100% of its value, and stocks don’t even do that very often.
But on the other hand, a stock can go up over 100 times in value. Prominent examples include Amazon, Microsoft and Tencent Holdings Ltd (SEHK:700).
I have traded Tencent several times in the last decade but the profit I generated was far less than I would have earned by just sitting on the shares; not to mention that I also incurred some losses when I pared my holdings at the wrong time.
From the 80/20 principle, 20% of winners will derive 80% returns of your portfolio. Of course, I have picked losers sometimes (we all do) but winners have more than outpaced the losers in the long run.
My belief is that investors should just embrace volatility and remain patient. You will be rewarded by explosive returns from a few handsome winners.
Foolish bottom line
Charlie Munger suggested not to waste time on ordinary opportunities but selectively focus on those that can improve your financial welfare drastically. Dare to win if you have picked a winning stock.
Winners keep winning in most cases! You never know if Shopify would be a 20-bagger or even a 100-bagger. Sell the stock only when your investment thesis no longer holds true or you see a better opportunity that you can allocate your capital to.
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John Mackey, CEO of Whole Foods Market, an Amazon subsidiary, is a member of The Motley Fool’s board of directors. Teresa Kersten, an employee of LinkedIn, a Microsoft subsidiary, is a member of The Motley Fool’s board of directors. The information provided is for general information purposes only and is not intended to be personalised investment or financial advice. Motley Fool Hong Kong contributor Hayes Chan owns shares in Shopify Inc.