100 Baggers - Book Review

By Lorenzo Ayres

Christopher W. Mayer

Category: Find the Deal

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The idea behind 100 Baggers starts in 1954, when a man named Thomas Phelps sold his Polaroid stock to pay a doctor's bill of $7,415, and he kept the confirmation slip afterwards as a reminder. Less than 20 years later that same stake was worth $843,000. Phelps was the Wall Street Journal's Washington bureau chief, an editor of Barron's, and finally a partner at Scudder, Stevens and Clark, and he retired to Nantucket after a 42 year career. Chuck Akre once described him as a Boston investment manager of no particular reputation. In 1972 Phelps wrote 100 to 1 in the Stock Market, out of print for decades until Echo Point reissued it, and in it he studied every stock that rose a hundredfold between 1932 and 1971 and found over 365 of them. Mayer's first chapter is written as a conversation with Phelps, and then Mayer admits the trick. He never met him. Phelps had been dead since 1992 and every line is from the 1972 book. That tells you what this book is. It’s Phelps’ rerun on modern data, by somebody who says so on the dedication page.

The rerun is the reason to own it. Working with Stephen Jones of String Advisors, Mayer built a database of every US stock that returned a 100 to one from 1962 through 2014 with dividends reinvested, excluding anything under $50 million of market capitalization in today's money before the run started, and he says the publisher spent more than $50,000 on the data. The result was 365 stocks, the same number Phelps found, which is a coincidence and nothing more. What those 365 looked like at the starting line broke my assumptions. Median sales of about $170 million and a median market capitalization of about $500 million, which puts the median price to sales ratio near three, and Mayer himself says that it "isn't classically cheap by any measure." So the myth that you need a tiny company is wrong, because $170 million of sales is a real operating business. And they weren’t obviously cheap on past numbers either. Small, not tiny, and not cheap. And slow: the average and median time to a hundredfold was 26 years, only twenty of the 365 did it inside 10 years, and 184 of them took somewhere between 16 and 30.

The mechanism is two things multiplying, which Mayer calls the twin engines. Earnings grow, and the market pays a higher multiple on the bigger earnings. His illustration is Hansen Natural, which became Monster. Four cents of earnings per share in 2001 at a price-to-earnings ratio of 10, about a dollar in 2006 at a ratio of 50. Earnings up 25 times, the stock up 125 times. Behind the engines is the one principle he says everything else is ancillary to: which is a business that earns a high return on capital and can put its own earnings back to work at that same rate for years. Jason Donville's table on Home Capital makes it: 15 years of returns on equity between 20 and 31 percent produced a 49-bagger in 16 years, at an annualized return of about 28 percent, sitting right on top of the return on equity itself. Because holding for 26 years is the hard part, chapter three gives you the coffee can portfolio, from Robert Kirby of Capital Group writing in 1984 about a widow whose late husband had secretly copied every one of Kirby's buy recommendations and ignored every sell. The untouched account had beaten the managed one badly. Mayer's line for why it works is that "It keeps your worst instincts from hurting you."

Now the Monster case, because I’ve described it wrong in the past and that’s embarrassing. Hilton Schlosberg and Rodney Sacks, both immigrants from South Africa, paid $14.5 million in 1992 for Hansen's Natural Soda and Apple Juice, a company dating back to the 1930s with no best-selling product and barely any national distribution. They decided from the start it would be a marketing and branding company with no manufacturing of its own, like Coca-Cola. Their first energy drink, Hansen Energy in an eight-ounce can, got crushed by Red Bull, which for years spent wildly out of proportion to its own sales to build the brand. By the turn of the century the product list was almost absurd, sodas and smoothies in four sizes, children's vitamin drinks, green tea, food bars, cereal. The first real move was cutting it down. Monster launched in 2002 into the 16-ounce niche, and this time they spent. Sales and marketing employees went from 66 in 2001 to 591 in 2006. Net sales went from $92 million in 2002 to $606 million in 2006, gross margin from 35 to 52 percent, return on equity from 11 to 50 and somebody who bought in 2004, well into the story, still made a 100 times their money. What I used to say was that they took an existing product and made it premium. I was wrong about that. A sixteen ounce can at roughly the price of an 8.3-ounce Red Bull is more for the same money, not premium. The real move was cutting the range to one thing and putting nearly 600 sales and marketing people behind it. Same dirt, same steel, and the mechanism is the headcount table.

Here is the problem with the method, and Mayer is more candid about it than most authors would be, which does not make it go away. The study only sees the 365 that made it. Every principle in the book is extracted from survivors, and there is no control group of companies that earned high returns on capital, reinvested hard and went to zero anyway ,and there were plenty of those in numbers nobody counted. The $50 million floor quietly removes the size range where most of the blow ups live, which flatters the sample further. The evidence is sitting in his own fastest to a hundredfold table, which lists Valeant at 6.5 years and Questcor at 5.0, and both came apart within a year or two of publication, because growth, growth and more growth screened them straight in. The advice that follows, concentrate, bet half Kelly, be a reluctant seller, is high variance advice dressed up as patience, and the anybody can do this chapter is a set of people who happened to hold the right thing. It was published by a newsletter house, its case studies were written by newsletter analysts, and its author was selling a newsletter at the time.

What I use it for is not stocks. We have about forty cabins going up in the tree lines right now, which is reinvestment of operating cash flow, the exact thing Mayer says everything else is ancillary to. So his framework asks the only question that matters, which is what the return on that incremental capital, measured per bed, against what the same money would return applied to the $9.35 million of notes we’re refinancing. On the owner operator test he would have no complaint. Martin Sosnoff's rule in chapter seven is to throw away the proxy if management and the board own less than 10 to 20 percent, and I’ve personally guaranteed every dollar of the park's debt, twice. There’s also a small joke in the appendix, which lists all 365 names, and Polaris Industries is on it, having dominated a niche and compounded for decades. Polaris is my fleet vendor, and right now Polaris wants $100,000 or the machines get shut off, so I am reading about a 100-bagger in the back of one book and arguing with the same company in another window. And then there’s the part I keep circling. The coffee can says never sell a piece of something that compounds, and my cabin investor structure does exactly that, selling individual units of the asset early because it funds the next 40. This book is the strongest argument against my own structure that I have read. I haven’t answered it, and the next 12 cabins get framed regardless.

About Lorenzo Ayres

Lorenzo Ayres is a business builder, dealmaker, and owner of America's Outdoor Adventure Park in Jay, Oklahoma. Here he reviews books on investing, deal structure, and business strategy.

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