ETMarkets PMS Talk | ‘A narrative has to be supported by numbers’: Anil Rego on finding real multibaggers of the future
Rego says the firm’s multibagger framework looks for emerging leaders where earnings could potentially double over the next three to five years, while valuations remain reasonable. The focus is on identifying businesses where the fundamentals are improving before the market fully recognises their potential.
But in the mid- and smallcap space, where compelling narratives can sometimes mask weak fundamentals, Rego says investors need to distinguish genuine growth from a value trap. From promoter pledging and leverage to ROCE, cash flows and competitive positioning, he explains the key filters Right Horizons uses to separate businesses with scalable growth potential from stocks driven primarily by a good story.
In this edition of ETMarkets Smart Talk, Anil Rego takes us through his multibagger playbook, the lessons from the 27 multibaggers identified in the last cycle, and where he sees opportunities emerging over the next three to five years. Edited Excerpts –
Q) Your portfolio has delivered strong returns across multiple periods, but investors often focus on point-to-point performance. Why do you believe rolling returns are a better measure of the sustainability and consistency of a PMS strategy?
A) I prefer looking at rolling returns because point-to-point performance tells you what happened between just two specific dates, and that can be significantly influenced by the market level at the time of entry and exit. Rolling returns solve for that by taking every possible starting point across a period rather than just the two dates you happen to pick.
For instance, if you take a 1-year rolling return within a 5-year period, you don’t get one number, you get close to 1,100 individual return instances. So the real question for an investor evaluating past performance is: would you rather draw a conclusion from a single point-to-point return, or from roughly 1,100 different 1-year instances captured across that period, through different market conditions?
Rolling returns give you the full range of outcomes, the best phases and the weakest ones, rather than one result that could simply reflect a favourable entry or exit point.For us, the key question is whether the investment process has been able to generate returns consistently rather than whether we have performed well during one particular market phase. In Super Value, our 1-year rolling return is 18.99% compared with 14.24% for the BSE 500 TRI, while the 3-year rolling return is 20.96% compared with 16.62%.
So, I believe rolling returns are a more meaningful way of evaluating a long-term PMS strategy because they help investors understand the consistency of the investment process across hundreds of different entry points and market cycles, rather than being influenced by one favourable point-to-point period.
Q) The numbers show that the strategy has outperformed the BSE 500 TRI across 1-year, 3-year, 5-year and 10-year periods. What were the key elements of the investment process that helped you generate both alpha and consistency across different market cycles?
A) The consistency has come primarily from staying disciplined with our investment process across market cycles, rather than changing the philosophy based on short-term market movements.
Being process-oriented, rather than depending purely on individual judgement, is really what helps bring that consistency — it takes away a lot of the behavioural biases that can creep in during euphoric or fearful markets, whether that’s chasing momentum in a rally or turning overly conservative in a correction.
We follow a bottom-up approach, looking for businesses that can deliver strong earnings growth, maintain capital efficiency and have sustainable competitive advantages, while ensuring that we are not overpaying for that growth.
Our process combines the RH Screener, Scorecard, Risk Radar and Pendulum, which help us evaluate growth, valuations, balance-sheet strength, governance and business quality, while continuously monitoring changes in fundamentals and macro conditions. Having this structure in place also means our decisions depend far less on any one individual’s view or mood at a point in time.
Portfolio construction has also been important. Around 80% is typically focused on capital-efficient, high-growth businesses, while the satellite portfolio provides room for turnaround or contrarian opportunities where we see a higher margin of safety and favourable risk-reward.
Ultimately, I would attribute the alpha to stock selection, earnings compounding and valuation discipline, while the consistency has come from applying the same structured process — and the objectivity it brings — through both favourable and difficult market environments.
Q) You also have a separate multibagger framework aimed at identifying companies that can create outsized wealth. How does this framework differ from your core stock-selection process, and what are the early signals you look for before a stock becomes a potential multibaggers?
A) The multibagger framework is an extension of our core stock-selection process rather than a separate philosophy. Our core process first ensures that a company meets our requirements on business quality, balance-sheet strength, governance, growth and valuation. The multibagger framework then looks at whether that business has the potential to compound earnings meaningfully and emerge as a much larger company over time.
The two key pillars we focus on are growth and value. We look for businesses where earnings have the potential to double over the next three to five years, supported by above-industry growth in revenues and profitability.
At the same time, valuations need to be reasonable so that returns are driven primarily by earnings growth, with the possibility of additional upside from a re-rating as the market starts recognising the company as an emerging leader.
The early signals we typically look for are accelerating earnings, improving competitive positioning, capital efficiency, a scalable opportunity and clean governance. The objective is to identify these characteristics early, before the improvement in the business is fully reflected in valuations.
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Q) You have identified 27 multibaggers in the last cycle. Looking back, what common characteristics did these businesses share at the time you first identified them—and how different did they look from the market favourites of that period?
A) For us, identifying 27 multibaggers within a single cycle is itself a validation of the multibagger framework — it shows that the process of looking for growth at a reasonable valuation isn’t a one-off outcome, but repeatable across a fairly wide set of businesses.
When we look back at the multibaggers we identified, a few characteristics were common. These were generally emerging leaders rather than established market leaders. They were operating in businesses with a large growth opportunity, gaining market share and, importantly, demonstrating earnings growth that was significantly ahead of the industry.
What made them interesting to us was the combination of growth and reasonable valuation. We were looking for businesses where earnings could potentially double over three to five years, but where the market had not yet fully recognised that growth.
Interestingly, when we look at how the actual returns played out, in some cases it was largely earnings growth that did the heavy lifting, in others it was the re-rating as the market woke up to the story, and in quite a few names it was a combination of both, earnings compounding and the valuation gap with larger industry leaders narrowing at the same time.
So they often looked quite different from the market favourites of the time. The favourites were typically already well discovered, whereas many of these companies were mid- and small-cap businesses that were relatively under-researched and available at more reasonable valuations.
For us, the opportunity was to identify the change in the business before it became obvious in the stock price.
Q) In mid- and smallcaps, the line between a potential multibagger and a value trap can be thin. How does your process distinguish between a business that is genuinely entering a high-growth phase and one whose valuation is simply reflecting an attractive narrative?
A) The distinction for us is that a narrative has to be supported by numbers. In mid- and small-caps, there will always be attractive stories, but we look at a combination of factors before getting convinced — whether the business genuinely has sector or structural tailwinds behind it, whether the actual numbers, revenue, earnings, cash flows, are validating that story, and whether the management is showing a genuine growth mindset, the ambition and the ability to actually scale the business rather than just talk about it.
Our process focuses on revenue and earnings growth, ROCE, balance-sheet strength, cash flows, promoter quality and governance, along with whether the company is strengthening its competitive position. We also look at whether growth is sustainable and whether the valuation is justified by that growth.
Our framework specifically avoids businesses with characteristics such as highly leveraged balance sheets, uncertain paths to profitability, poor disclosures or low promoter alignment.
Having a structured process really helps bring a certain hygiene to this — it stops us from getting carried away by a good story alone. Most importantly, it means we continuously revisit the investment thesis as the numbers evolve, rather than remaining anchored to the original narrative.
So, for me, a potential multibagger is a business where the narrative is progressively getting validated by the tailwinds actually playing out, the numbers, and the management delivering on execution. If earnings do not follow the narrative, or valuations move significantly ahead of fundamentals, that is where we become cautious.
Q) Your investment process looks at parameters such as three-year revenue CAGR, ROCE, debt, operating profit, promoter pledging and valuation. Which of these metrics tend to be the biggest red flags, and which ones can signal that a company deserves deeper research?
A) For me, some of the biggest red flags are around leverage, promoter pledging and governance. As a screening threshold, promoter pledging beyond 20% would make us cautious and require a much deeper understanding of the reasons behind it. Poor disclosures, aggressive capital allocation or an uncertain path to profitability are also areas where we would generally be uncomfortable.
On the positive side, our initial screening looks for evidence that the business has already demonstrated a reasonable level of quality and growth.
We typically look for 3-year average ROE and ROCE above 12% and 3-year PAT CAGR above 8%. These are not investment decisions by themselves, but filters that help us identify companies deserving deeper research.
From there, we evaluate the business moat, management quality, growth opportunity, balance sheet and valuation. Ultimately, we want to see growth, capital efficiency and governance coming together rather than relying on any single financial metric.
Q) After the strong rally in mid- and smallcaps, where are you still finding mispriced opportunities today? Are you seeing more potential in emerging businesses, turnaround stories, or established companies undergoing a structural transformation?
A) I would say opportunities are still available, but after the strong rally, we have to be much more selective and bottom-up in our approach. We are not looking at mid- and small-caps as a broad opportunity; we are looking for specific businesses where the earnings potential is still not fully reflected in valuations.
Our preference is largely towards emerging profitable businesses in sectors with structural tailwinds, where companies can grow faster than the industry, gain market share and potentially emerge as future leaders.
Some of the structural themes we like today include Manufacturing, within which we particularly like niche pockets such as EMS and building materials, as well as Hospitals and Wealth Management — all of which we believe have genuine multi-year tailwinds behind them.
The strategy specifically seeks opportunities in higher-growth mid- and small-cap companies within such themes, including relatively under-researched businesses where valuations can still be attractive.
We also look at turnaround and structural transformation opportunities, but there we need clear evidence of improving fundamentals, capital efficiency and earnings visibility rather than just an attractive narrative.
So, the mispricing we are looking for today is essentially where the business and earnings trajectory are improving faster than what the market is currently pricing in.
Q) If you were to look ahead over the next 3–5 years, which characteristics—not sectors or individual stocks—could define the next generation of multibaggers in India?
A) Over the next three to five years, I believe the next generation of multibaggers will come from companies operating in sectors with strong structural tailwinds, where the underlying industry itself has a long runway for growth.
Within those sectors, our focus would be on businesses that can grow faster than the industry, gain market share and potentially double their earnings over three to five years.
We would particularly look for emerging leaders with scalable business models, strong competitive advantages, healthy ROE and ROCE, prudent balance sheets, clean governance and good capital allocation.
Finally, valuation remains equally important. We want to identify these businesses before their earnings potential is fully recognised by the market. So, the combination we look for is: sector tailwinds + market-share gains + strong earnings growth + capital efficiency + clean governance + reasonable valuation.
(Disclaimer: Recommendations, suggestions, views, and opinions given by experts are their own. These do not represent the views of the Economic Times)
