How to nail a 10 bagger
used by big talkers in Silicon Valley. It’s the
same thing, but I like the older terminology.
Owning less than a handful of 10 baggers
in your lifetime can meaningfully impact
your financial position. And online lottery
ticket reseller Jumbo Interactive (ASX: JIN)
has now become a 10 bagger for those who
bought around the time of its first mention in
this column back in October 2012, when it was
trading at about $1.20 per share. It’s now a 50
bagger based on the first shares I purchased
for my family at 30¢ each (I bought more
shares at higher prices as the story unfolded).
It’s worthwhile revisiting the story to see
what factors were at play in such a profitable
result and to draw out a few key points that
might increase our odds of spotting the next
10 bagger.Original case
In October 2012, I made a case for backing
online lottery tickets: “Compared to lining
up at the newsagent, or the prospect of a
pocketed winning ticket going through the
wash, playing the lottery online makes plenty
of sense. In the same way those who’ve moved
to paying bills online will never go back to
lining up for the task at the post office (as
my 69-year-old father continues to do, for
reasons best known to himself), once people
begin playing the lottery online, they tend to
stick with it.”
Back then, around 8% of Australian lottery
tickets were sold online. Today that figure
is more than 20% and growing. The factors
behind the trend haven’t changed and I expect
it to continue long into the future as older
consumers, who tend to buy fewer tickets
online, are replaced by tech-savvy younger
ticket purchasers.
This can be a good point to look for in a
potential 10 bagger – a company being pushed
along by a strong industry tailwind. Another
way of expressing this is to say that the trend
towards online lottery ticket sales had (and
still has) a “long growth runway”.
The top table (see opposite page) shows some
of Jumbo’s key statistics from 2012, including
my forecast for the 2019 financial year.Thesehigh-levelnumbersdon’ttellthe
wholestory,though.That’sbecauseJumbo’s
managementteammadeexpensiveforays
intooverseasmarketsthatcostshareholders
manymillionsofdollarsinthemiddlepart
ofthisperiod.
ThesecondtableshowsonlytheAustral-
ianbusinessoverthesameperiodasthe
firsttable.It demonstratesthestrengthand
consistencyoftheAustralianbusinessby
strippingawaythelossesfrominternational
operations.Therewerevariationsalongthe
wayduetosomeyearswhena runofhigh
jackpotsdrovehigherinterestinlotteries,
buttheoveralltrendis clear.
Thevalueof thiskindof “segment”analysis
washighlightedintheMarch 2016 edition
ofthiscolumn,usingJumboasanexample.Boostforthebottomline
What’salsoclearinthesenumbersis Jum-
bo’sincreased“scalability”.Thisis financial
jargonforrevenueincreasesfallingtothe
bottomlineat a fasterratethanin thepast.For
instance,Jumbo’sAustralianbusinessrecorded
$5.6million more revenue in 2015 than it did
in 2014 and 23.2% of this ($1.3 million) fell to
the bottom line as pre-tax profit.
This year, I expect the business to increase
its revenue by $21.7 million on 2018 and for
virtually all of that to flow through to the
bottom line as pre-tax profit. The effect is
that a 55% rise in revenue should see profit
rise by around 100%.
As a thought experiment, imagine if JB Hi-Fi
or Woolworths were somehow able to open
50% more stores and increase their revenues
by that amount. I’d probably expect their
profits to rise by a similar amount – maybe
65% or 70% at the maximum (due to some
benefits from fixed advertising and distri-
bution costs). But they certainly wouldn’t
get the same magnifying effect as an online
business like Jumbo.
So scalability is rightly valued highly by
investors. And that’s why investors are cur-
rently prepared to pay more for each dollar of
Jumbo’s profit than they have in the past. In
2012, investors were paying $8 or $9 for every$1 of Jumbo’s profits. Today they are paying
around $40 (based on 2019’s likely profit).
That’s a high number and one deserved only
by those businesses able to grow their profits
quickly. As a rough guide, investors might pay
$15 or $16 for each $1 of profit produced by an
average company on the ASX.
This valuation expansion is the final ingre-
dientinour 10 baggercocktail,which now
consistsofthesefiveparts:- Anattractivestartingvaluation.
- A longgrowthrunway.
- A defensiblecompetitiveposition.
- Scalablebusinesseconomics.
- A valuation re-rating.
There are other ways to 10-bag. For exam-
ple, buying a company that is on the verge
of going bust but somehow manages to pull
through is another, riskier, path. But the for-
mula above is one that has worked well for
me with stocks such as Jumbo and Pinnacle
Investment Management (PNI), which have
featured regularly in this column.
Of course, that’s the way things go in the
brochure, not always in real life. But if you
don’t even have a road map to begin with,
then your chances of success are diminished.
I’m hopeful that stocks previously covered
in this column – such as Matrix Composites
& Engineering (MCE), Smart Parking (SPZ)
and Swick Mining Services (SWK) – might all
benefit from this game plan to some extent.
But chances are that at least one or two will
continue to disappoint.
The good news is that just a couple of 10
baggers can make up for quite a few duds.
But they’re rare and if there’s a surefire way
to identify them in advance and avoid the
look-alikes that end up disappointing, then
I haven’t found it yet. M
Greg Hoffman is an independent financial
educator, commentator and investor. He is
also non-executive chairman of Forager Funds
Management (not involved in Forager’s invest-
ment process).
Disclosure: Private portfolios managed by
Greg Hoffman own shares in JIN, PNI, MCE,
SPZ and SWK.