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What is so Wrong with 10-baggers?

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By PaulEngr
December 28, 2004

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The whole issue of searching for 10-baggers reminds me of Don Quixote's tilting at windmills. Madness? That is in the eyes of the beholder. I can appreciate what Quixote was doing, but it's certainly not for me.

Ten Bagger Theory
When I first started reading TMF, and eventually joined a few months later, I felt the same thing. There was a lot of good around here, and then there were things like the Rule Breaker portfolios.

Try as much as I could, I simply couldn't get my head wrapped around the idea. Every time I looked at those stocks (and I looked from a value investing point of view), they looked mediocre at best. It took a "true believer" to really believe that for instance, AOL was going to double in 3-5 years in the face of charging significantly more money for the exact same service as the competition and in the face of falling prices.

Yet year on year, the Rule Breaker portfolio paid off. I never invested a dime in anything recommended, simply because that strategy is not for me. An "old economy" guy that is perfectly willing and happy to go work for a 2000+ year old chemical industry (making lime) is simply not of the mindset necessary to work and invest in the world of biotechs, nanotechs, and tech-tech's (AOL and the like).

You can look at the 2/3/5/10-bagger world as a continuum of investment possibilities. At the very bottom of that hill, we find index funds and "Rule Makers"...stuff that is going to slowly, inexorably, make a slow and steady climb towards profitability at a definite and known rate over the long term. Let's face's boring. That is both the great advantage and the great enigma of the bottom of the hill.

Then as you move up the hill, you next encounter either "growth stocks" or "value" stocks, depending on your point of view. Frequently, the most popular prospects tend to be large caps with their somewhat volatile but very predictable price trends.

Towards the top of the hill are the 10-baggers. Out there, the chances for success are really thin, but still, it's nice to dream. Not all dreamers end up broke either.

Evidence for 10-bagger Theory
I believe there is substantial evidence for the existence of people enamored with the idea of questing after 10 baggers in the TMF Community. The biotech and nanotech boards are extremely popular. The "metals & mining board" is almost exclusively dominated by gold bugs (which is just a variation on the theme).

Although perhaps not as lofty as full-fledged 10-baggers, the value of Rule Breaker investing cannot be denied, but it's not for me. Peter Lynch, the grandfather of the term 10-bagger, has demonstrated this sort of philosophy in his personal investments, which are transparent to us all due to SEC filing rules and search functions on the Edgars database.

As I've been reading over some of Peter Lynch's personal investments in small caps and microcaps (where a "tiny" investment forced Lynch to submit SEC filings since they exceeded 5% ownership), many of them were similar "crap shoots". Over 90% of them ended in utter failure. But just once in a while one of them turned out to be a fantastic investment. Fortunately, not all ended up worthless either. At least in this game, the odds are still slightly tilted against the house (the index world at the bottom of the hill boosts the top as well).

So let's see here. Let's say you've got a list of ten potential 10-baggers. Just one will be a real, live 10-bagger. Half will end up worthless (bankruptcies). The rest will end up averaging out to even money (gains and losses even out). This is pretty close to Lynch's own track record. The end result?

$1 X 10 = $10
$4.5 x 0 = $0
$4.5 x 1 = $4.5

Total return: $1.45 on a $10 investment, or 45% return. Not bad at all. Lynch appeared to be far too personally involved in my opinion which financially lowered his returns, but he definitely ended up with a very nice return for his efforts in the microcap and high risk world overall.

In my mind, 10-bagger investing is akin to so many other strategies that I'm perfectly comfortable with. Examples of different strategies that I've seen used effectively are bottom feeding for "inverted" stocks where the book value exceeds the stock price, investing in momentum stocks (CANSLIM comes to mind), the growth stock philosophy of investing base on potential profits alone regardless of intrinsic value, investing in a downtrodden stock because intrinsic value is much higher than stock price, or investing based on dividend track records.

Any self-respecting "growth" investor would scoff at the idea of investing in a lackluster stock whose value has been depressed simply due to bad legal news. A "value" investor would certainly panic at the sight of P/E's in the stratospheric range of 30-100. Yet, people make money with these strategies every day too.

Does 10-bagger investing have value? Definitely. Is it for me? Nope. Is it for wax? Nope. Is there a Fool Community following? Definitely.

I for one tip my hat (but not my jousting pike!) to the Don Quixote's everywhere who would tilt at the 10-baggers, regardless of whether I'm comfortable with those odds.

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