Mark Minervini is regarded as one of the most successful traders in the stock market, and he has sufficient proof to back it as the two-time US investing champion where he made 154% in 1997 and a mind-boggling 334% in 2021. These are some remarkable results and something we definitely should definitely study. This blog will aim to explain and study how Mark Minervini achieved triple-digit returns despite effective risk management.
There are two ways to make such great returns. One is if you take exorbitantly high risks and risk losing all your capital or making multibagger returns. I would not suggest this strategy as the expected returns will likely be disappointing because the probability distribution of such a strategy would be bell-shaped curve and the triple-digit returns would be near the tail end (very low probability)
Do you see the 0.1% mark? thats the probability of that particular event happening which in this case, will be the multi-bagger returns. To keep it simple and short, you will make 100%+ one out of a 100 times and probably end up in red for the most part. High risk high reward.
How do we ensure that the risk is minimised and that the probability and quantum of success are quite high? I call this approach the catalyst style of investing/ trading. I really do not know whether to call this an investing approach or a trading approach because it takes into account parts of both the philosophies while also disregarding some of them. The core of this strategy is to expose yourself to the key catalyst events which can either be fundamental or technical in nature which will be responsible for generating that big Alpha.
The Catalysts
Before I begin, I would like to say that I, too, look for such catalysts when investing and when I used to do trading. The combination of these is what Mark Minervini calls his trend template. However, I wish to dig a little deeper into the fundamental aspects as well and, hence, will list them separately. The thing that I like about this strategy is that we can look for businesses which have multiple catalysts at play and decide the ones that favour us the most. This strategy is better when used on companies with a 1000cr+ market cap as there is liquidity to entry/exit quickly, and the stock charts are better to read and have info to convey. This strategy is not meant for alpha creation in terms of discovery but alpha creation in terms of business momentum and rate of change.
The catalysts that can lead to significant returns are numerous and can be categorized into two groups: technicals and fundamentals. I personally give more weight to fundamentals when screening stocks, but this may not be the case for everyone. I encourage you to use this framework and adapt it to your own needs and preferences. Let's explore these catalysts and the potential they hold for high returns.
Technical catalysts
Requirements
In order to obtain a minimal chance of loss, I look for a few criterias that need to be met.
Trend: In my experience, It is easy to ride a trend continuation rather than picking a trend reversal. Hence, I look for businesses that are in the stage 2 or during the mark up phase as they are easy to spot and ride. Note: I buy businesses when they are under price correction, but that is me as an investor with a different mental model/ strategy; when I follow this strategy; it is essential to stick to the trend.
Favourable market dynamics:It is extremely difficult to understand the market cycles. However, we can attempt to gauge the position of the current markets by looking at valuations, growth expectations, and price action. To give an example, one could argue that there might be better times to initiate new positions currently as there are chances of time correction or price correction with respect to valuations. I would bet heavily and concentrate when markets are in our favour. It becomes subjective in terms of understanding 'favour', but looking at market valuations, sector valuations, the relative strength of that sector, and specific stocks will help.
Relative strength: The relative strength rating is no less than 70, and preferable in the 80s or 90s, which will generally be the case with the better selections. We want the leaders and nothing else. Relative strength is a great way to find them.
52 week high: There is this belief that 52 week low stocks will bounce back while the 52 week high ones will correct. No, let business momentum do its thing and bet on the ones who have fundamentals backing them. Go look at pharma and real estate businesses right now, they crossed their 52 week high and continued going because there are genuine triggers behind them. Hence, look for businesses that are close to their 52 week high.
So these were just the requirements, where do we find technical 'catalyst triggers?'
VCP: VCP stands for volatility contraction patterns which suggests that the price is at an equilibrium of supply and demand and any spike on either side would lead to huge price fluctuations. Keeping track of businesses near 52 week high that are currently showing such patterns can generate great returns.
Expanding volumes: Finding businesses with high volumes isa good shortcut to find where the money is flowing. You will generally see post VCP price expansion with volume expansion together (check images below)
Sectoral moves: Do you struggle with fundamentals? fear not, an efficent way to fast track this is by tracking group moves. More often than not, stocks that move in groups have a fundamental reason/ a sectoral cyclical upswing that is helping the whole industry generate abnormal returns.
This will not work all the time, but the odds are in your favour as the upside is huge, the downside limited and most importantly: the odds of success will be high if there are fundamental reasons backing it.
Timing the stock
We can not pounce on the first signs of price breaking out of the VCP. I would suggest everyone to time the entries at the end of the day even if it means buying at a higher price. This eliminates faulty trades and increases certainty.
Fundamental Catalysts
Mark Minervini emphasises on buying technically strong stocks that are backed by fundamental catalysts. Although technical catalysts are easier to screen and buy, Fundamental catalysts are the ones that will help build conviction and help you decide what to buy.
New Product : Imagine I am selling flour and sugar to bakeries, which are commoditised products with no bargaining power and low margins. However, I start production of sweets under a brand name and ensure good quality. What will happen? I can sell these products with some bargaining power, higher margins and differentiation. These businesses that go downstream in their value chain can create a lot of wealth as the margins and return ratios improve, but so do the prospects of the quality of business. Another thing to track in product change is the quality of earnings. An EPC business which has lumpy revenues changes its model to build and operate, which means the cash flows become very consistent and hence valuations stand to expand.
Industry turnaround/trend :Industries show signs of turnaround/trend (positive or negative) when there is a supply-demand mismatch. As a catalyst investor, our job is to find these mismatches in our favour. This means that demand is high and supply is limited, which translates to higher margins, high capacity utilisation and the potential to expand capacity( which becomes the next leg of growth.) Some examples where we are witnessing a supply-demand mismatch and where businesses have done really well are Real estate, hotels, aviation, co-working spaces, cables and wires etc.
Operating leverage: When a business can grow its earnings faster than its revenue, it leads to an abnormal rise in EPS and, in most cases, stock price as well. How does operating leverage play out? Its either margin expansion or by keeping the costs consistent. Margin expansion is quite simple; you sell products with better margins or become more cost-effective. Keeping costs consistent means having a higher share of fixed costs against total costs. For example, a business running a factory at 20% utilisation against a 100% utilisation will pay the exact interest costs, depreciation costs, rent, etc.
Deleveraging: When a business startd paying off its debt, it increases its earnings and its balance sheet strength. This is a good way of capital allocation as it increases earnings but most importantly, the terminal value of a business as well.
Management change: Management plays a key role in a business. It is their ambitions, execution and business direction that will play a critical role in determining your future returns. A lot of the times the business is promising but the management is holding it back. Hence, we must track management changes that can play a pivotal role in business operations.
Special situations: If gotten right, they can be huge wealth creators. Special situations include mergers/demergers, regulatory changes such as anti-dumping, corporarate restructuring etc. I am yet to learn this but Tar or Tareeq Hussain from TheWrap is a good source to learn from. I would highly recommend his subscription (no vested interest.)
Exit
There are multiple ways to look at exiting. I look at it in two ways.
First, if the catalyst fails (the reason you bought the stock; the main driver should be a fundamentally driven thesis) then I will say sell immediately.
However, if it does work out and the stock price picks off. It is important to hold it and make the most of the gains. in such a scenario, I will wait to see if there is a price weakness (stage 3,4) AND valuations being over extended. This way, I can rouglhy say that the risk reward is not in my favour and hence it is better to look for different opportunities.
These are some of the active catalysts that I look for and believe can help in alpha creation. This approach allows a lot of flexibility in terms of preferences and market dynamics while also keeps the direction of the strategy clear. I have learnt a lot about this from Ishmohit sir of SOIC and would also recommend watching his videos on variant perception and the recently done Hyderabad conference. I hope this blog was helpful.
Thank you.
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