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I recently wrote about how a few big winners in your portfolio markedly change the overall returns you get.
That column, titled Once you’ve found the brilliant share, don’t sell (7 September issue) looked at holding on to the winner, which is harder than it sounds.
Buying a stock at, say, 1 000c and then watching it head off to 2 000c, 5 000c, R100, R500 sounds great, but how many of us would exit at double or triple return and miss the real large move to R500, for example?
This week I’m focusing on how we should go about finding these few massive winners. Certainly, this is neither easy and nor is it an exact science; if it was, everybody would be rich.
We have to identify these winners when they have potential and not be scared to dive in if they’ve already started moving.
Any 10-bagger (an investment that appreciates to 10 times its initial purchase price) has to be a one-bagger, and even buying a stock that has doubled can lead to massive profits as it doubles again and again.
Most people would look for small-cap disruptors, but I have concerns about this strategy. A high risk is associated with small caps because – frankly – most fail.
Sure, some succeed, and a very small number become amazing large-cap stocks, but very few make it. It is also worth considering that every trillion-rand company was once worth only R50bn and before that even less.
Don’t be afraid of the larger-cap stocks.
Trying to find true disruptors bothers me as well, as disruption usually fails. Tesla has done great things so far, but the risks for the company are larger than ever.
It has to deliver more cars annually than ever before, and the other entrenched automanufacturers are starting to produce their own electric cars, so competition is heating up.
I personally prefer innovation over disruption – small tweaks to an existing business model that change the game.
Here Capitec* is the best example. There is nothing new about banking; it’s been around forever, but a few small adjustments have seen this bank become one of the largest and most profitable in South Africa.
The innovation was centralised systems that seriously reduced costs. The bank also focused on customer needs with regard to branch placements and operating hours.
The latter makes Capitec a darling with customers, and the former enables the bank to offer the cheapest accounts, generating larger profits than its peers.
So you should rather look for small tweaks to a successful business model that will make all the difference.
Shoprite* did it with central distribution, Famous Brands* did it with vertical integration, and Bidvest did it with excellent capital allocation.
None of these examples are major disruption, rather minor changes that boosted profits, putting these companies ahead of competition.
Apple did not make the first smartphone, it just did it better.
Looking forward, here are some potential innovators to watch. Discovery* is tweaking things by making its customers healthier and tracking how much exercise they’re doing.
Healthy customers make fewer claims, which boosts the company’s profits.
Adapt IT is bulking up in growth areas of education and finance as well as oil and gas using the EOH acquisition model to grow ahead of normal organic returns.
Steinhoff (notwithstanding its other issues) is a master at supply chain integration, owning all parts of the chain from production to sale.
Aspen has focused on generics and bought global brands cheaply to roll out, while Mr?Price sold fashionable clothes on the cheap for cash.
The last three examples may raise some eyebrows when one considers current share price performance. But as I wrote recently, even the major winners will experience tough times, and we need to trust both in the company and in our selection.
*The writer owns shares in Capitec, Shoprite, Famous Brands and Discovery.
This article originally appeared in the 21 September edition of finweek. Buy and download the magazine here.
