Finding that company which could be the next 10- to 100-bagger is the holy grail of value investing and there’re five paths that could lead to the next 100-bagger (or six if you include Gamestop).
Focused Mousetraps. These are businesses that focus narrowly in one area with long runways. Examples include Costco, which focuses on retail, and Chipotle and McDonald’s, which focus on fast food.
Great Capital Allocators. These companies’ management are skilled at reinvesting retained earnings organically or inorganically (i.e., through acquisitions). Examples include Berkshire Hathaway and Danaher.
Uber Cannibals. These are companies with an intense focus on buying back shares. While their earnings don’t grow, your share of the earnings grows. Examples include Autozone and NVR.
Deeply Undervalued Turnarounds or Public Leveraged Buyouts. These companies generally have a catalyst happening which would unlock value. Examples include Fiat Chrysler and Rain Industries.
- Fiat Chrysler – 菲亚特·克莱斯勒
Spawners. These are companies capable of spawning related and unrelated businesses and it’s very rare for a company to possess the DNA to be a great spawner. Examples include Amazon, Alphabet, Alibaba, Tencent, and Baidu.
What Is a Spawner?
A “spawner” is a company with the necessary DNA to incubate new businesses that have the potential to become the next massive growth engine.
- incubate – 孵化
For this to happen, the company should expect many failures, and must take these failures in its stride. The key is to start small first and scale only when success is found. Jeff Bezos’ 2017 letter to Amazon shareholders puts it best, “Staying in Day 1 requires you to experiment patiently, accept failures, plant seeds, protect saplings, and double down when you see customer delight.”
The big advantage of spawners is that they use pre-tax earnings to grow. Aggressively investing earnings into growing the business allows the company to grow its intrinsic value without paying taxes.
For example, Amazon hardly reports any earnings and is notorious for barely paying any taxes because of how aggressively they reinvest back into the company. Otherwise, approximately 30% of their earnings would have gone to the government.
- notorious – 臭名昭著
Compare this with Uber Cannibals or Great Capital Allocators who use after-tax earnings to buy back shares or for acquisitions—they have to pay taxes on their earnings first before they are able to buy back shares or buy into other companies.
The Different Types of Spawners
Capitalism is extremely brutal. Almost all businesses will mature and die, and spawning helps keep the company alive.
There are five main types of spawners.
Adjacent Spawns. This group of companies are able to grow by venturing into adjacent markets with related products. An example is Starbucks, who grew from having coffee houses to Frappuccino bottles, Verismo coffee machines, Starbucks Reserve, and Starbucks alcohol.
Embryonic Spawns. This group of companies are able to acquire new businesses and nurture them into larger businesses. Over the years Facebook has acquired Instagram, Whatsapp, and Oculus VR and grew them into much larger businesses.
- Embryonic – 萌芽期的
Cloner Spawns. These companies don’t innovate, they simply copy successful products. Microsoft is an example, with Explorer, Surface, Azure, and Teams.
Non-Adjacent Spawns. This group creates or buys businesses in unrelated areas. BYD Company is an example, going from electric vehicles to face mask manufacturing and many others.
Apex Spawners. These are the best spawners and they deploy the spawning tactics of all the above. Most 10- to 100-baggers belong to this category. Examples include Amazon, Alphabet, Alibaba Group, Berkshire Hathaway, and Baidu.
Most companies do not have the DNA to be spawners, even if they’re exceptional businesses. They have an intense focus on the core business and view ancillary businesses as potential distractions.
Even if they stumble onto a great business, they tend to get rid of it way too early to avoid the risk of derailing the core enterprise. For example, McDonald’s spotted Chipotle early on and took a stake of more than 20%. However, they felt that it was a distraction and divested its Chipotle stake in 2006 even though there was a long runway. Chipotle share price has since appreciated 3200%.
- Chipotle – 墨西哥风味快餐，美国连锁餐饮
Most of a non-spawner’s excess cash is used for paying out dividends or share buybacks, and the earnings would be subjected to corporate income tax.
Pabrai’s Rules For Hunting Spawners
There were over 3,700 IPOs in the US over the last 20 years and only nine businesses grew to exceed $100 billion market cap.
In your hunt for a multi-bagger spawner, assume that it will not grow beyond the $50 billion market cap and work backward. If you want a 10-bagger, hunt below the $5 billion market cap and if you are hunting for a 100-bagger, hunt below the $500 million market cap.
While Amazon has been a great apex spawner, it is unlikely to become the next 100-bagger. With a current market cap of $1.6 trillion, it needs to grow into $166 trillion to become a 100-bagger.
When hunting for spawners, look at the history of the business and ask if (1) it has demonstrated strong spawning DNA, and (2) it has a great capital allocator at the helm.
Identifying signs of an apex spawner ideally below $500 million in market cap would likely mean that you’ve found the holy grail.