How Mutual Fund Managers find multibaggers? Ft. Aditya Khemani

ELI5/TLDR

A veteran fund manager explains that nobody picks a 10x stock on purpose — you only know it was a multibagger in hindsight. The real game is boring: find a decent business run by a still-hungry owner that can compound earnings ~15-25% a year, hold it, and let arithmetic do the work. He also argues that small and mid cap companies are far less risky than people think, and that the most interesting sectors in India simply don’t exist in large caps. Realistic expectations matter: stop hoping for the 2021-style fireworks; 13-14% a year is a perfectly good outcome.

The Full Story

The guest is Aditya Khemani, who runs small cap, mid cap and large-and-mid cap funds at Invesco, with nineteen years in the market. The host, Amrita Rora, spends the episode mostly on one category: the small and mid cap space. What comes through is a fund manager who is allergic to drama and fond of arithmetic.

First, the map: large, mid, small

The labels are just rankings. Take India’s listed companies and sort them by size. The top 100 are large cap. Numbers 101 to 250 are mid cap. Everything from 251 onward is small cap. That’s the whole definition.

This matters because “small/mid cap” sounds scary and “large cap” sounds safe, and Khemani thinks that instinct is outdated.

“The biggest mid cap company, the 101st company — its market cap is broadly one lakh crore, with twenty-five hundred crore of profit. How can you call a one-lakh-crore, profit-making company risky?”

His point: a mid cap today is a genuinely big, established business — not a fragile startup. Risk has dropped a lot versus ten or fifteen years ago. The genuinely fragile names sit at the very bottom — a ₹5,000 crore company is riskier than a ₹10,000 crore one. And even risk depends on the business model, not the size label. A small cap hospital chain is steadier than a large cap metal company, because the metal company’s fortunes ride on Chinese steel prices it can’t control.

The one honest caveat: over short windows, small/mid caps fall harder, because they’re less liquid. In a meltdown they correct more. But stretch the horizon to five or ten years and that price risk gets absorbed by earnings growth. Think of it like a small boat versus a tanker — the small boat rocks more in a storm, but if you’re crossing an ocean, what matters is where it ends up.

Why bother with small/mid caps at all: the sectors live there

This was the most useful idea in the conversation. Many of India’s interesting sectors only exist in small and mid cap. There is no large cap option to buy.

“Asset management industry — all companies are mid cap, not even one is a large cap. Wealth management — none. Exchanges — none. Auto ancillary — not even one large cap, all are small and mid cap.”

Add hospitals (only became large cap very recently), EMS — electronics manufacturing services — and CDMO, the pharma contract-manufacturing sunrise sector. These are emerging or structurally mid-sized industries, so by definition you can only “play” them through smaller companies. Large caps, by contrast, give you the same crowded handful — banks, IT, financials. So a small/mid cap fund is closer to a representation of the whole economy.

The exception he flags is banking, and it’s a sharp one. In banking, the big guy genuinely beats the small guy: a large bank has a stronger deposit franchise and the public’s trust, and can outspend a small bank on technology. So in a small/mid cap fund, he deliberately under-plays banks — you take that sector in large cap instead.

The actual question: how do you find a multibagger?

Khemani’s answer is almost a refusal to answer, and that’s the point.

“Ask any good investor — at the time of investing, did they know it would be a multibagger? The answer is no. Always known in hindsight.”

A multibagger is just a stock that becomes a multiple of itself — 4x, 6x, 10x. The trap is treating it as a target. For every multibagger, ten stocks fail. He says, frankly, he doesn’t chase them in his own investing — because the thing that can 10x can also go to zero.

What he chases instead is a rate of compounding. Here’s the arithmetic that does the heavy lifting:

“At 25 percent compounding, money doubles in 3 years. So third year double, sixth year 4x, ninth year 8x, tenth year 10x. Even at 15 percent, money becomes 4x in 10 years.”

So the recipe isn’t “spot the rocket.” It’s: find good management, a good business, and a long runway where earnings can grow 15-25% a year. Buy it, then keep tracking — meet the company, re-check that your thesis isn’t breaking. Travel that 15-20-25% compounding journey, and the multibagger arrives on its own, eventually. He’s blunt that when you manage public money — other people’s hard-earned savings — your job is to keep your head down and own compounders, not to brag about the one rocket while staying quiet about the ten duds.

The Invesco process, in his words

Keep it simple, or it gets complicated. The whole team’s energy goes into meeting companies and identifying the right businesses and the right promoters — not into macro calls about wars or three-month views. The shape of it:

A deliberately small universe — about 300 stocks, not the 500-600 many houses track — built into portfolios of 45-50 high-conviction names.
Absolute return, not relative. The investor wants real money, not “we beat the index.” The floor is a company that can deliver at least 15% earnings CAGR over three years. That’s the starting filter.
Discipline on price — buying and selling at the right valuation — because no fund manager has an information edge anymore.

And one qualitative filter he keeps returning to: promoter “fire in the belly.”

“We have to remember — these mid cap promoters are not small people. A 30,000 crore to 1 lakh crore company, with a 50% promoter stake, means the promoter is worth 40-50 thousand crore.”

The danger is satisfaction. A promoter who’s 65-70 and has already made his fortune starts thinking about preservation rather than growth. For an investor, that’s poison — you’ve put money in and there’s no fruit. So he looks for owners who are still hungry, regardless of company size.

Reset your expectations

A recurring theme: people got spoiled. In the 2020-2024 stretch, stocks rose 15% in a month, companies were growing off a low base with margins expanding and a capex upcycle — a “goldilocks” period that won’t repeat. The last eighteen months disappointed a lot of people because that fantasy didn’t hold.

The anchor he keeps returning to: stock price return is linked to earnings growth. Nominal GDP is growing ~9-10%, so large caps can grow ~10-11% and small/mid caps maybe 13-14% (they’re smaller, so they grow faster). Expect 13-14% from a small/mid cap fund over the long run, with good managers maybe adding a bit.

And don’t feel cheated by that number. When inflation was 6-7% a few years ago, you needed 15-16% returns to feel like you were getting ahead. Now inflation is 3-4%, so on a purchasing-power basis, 13% today does the same work 15-16% did then.

Active vs passive, and where alpha now hides

If the index gives 13-14% too, why pay for active management? He’s honest that it’s gotten much harder to beat the index. Mid caps now have 15-20 analysts covering them; promoters host quality concalls and slick presentations; the market is crowded with PMS funds and family offices. Discovery is easy; there’s no information edge left.

So where does outperformance come from now? Not stock picking — portfolio construction. How you weight sectors, how much you put in the expensive name you avoided, how you behave when a stock falls (average down or sell). Plus tilting toward emerging themes the index under-weights — quick commerce, for instance, is tiny in the index, but an active manager who believes it’ll get big can over-allocate. It’s harder, and the answer isn’t clean: passive will win sometimes, active will win sometimes.

On valuation: important, but it’s an art

“People who think valuation isn’t important — I think they don’t know investing. Valuation is very, very important. The only thing is, it’s an art.”

Beauty is in the eye of the beholder, and so is a P/E multiple — one person calls 20x expensive, another calls 50x cheap. His real point: you can’t judge a stock cheap or dear off a one or two-year P/E. A company’s value comes from discounted future cash flows, and for a growth company, 60-70% of that value sits in the terminal value — the assumed growth ten-plus years out, which nobody actually knows. It’s a narrative. That’s why a one-year P/E tells you little; you have to look at the runway. As a small company scales, margins improve, working capital improves, cost of debt drops — earnings grow even faster than revenue. A mature 20-30 billion dollar IT services business can’t do that; its terminal value is lower, so the short-term P/E is more telling there.

How to spot an overheated market

Two red flags. First, the “sin” indicator: when everyone — including the paanwala — is talking about small and mid caps, it’s a usual sign. Second, and more rigorous: when price has run far ahead of earnings.

“If a company was 20 times five years ago and is 50 times today, the stock has become expensive — especially if earnings only grew 12% while the stock compounded at 25%.”

Valuation is the biggest tell. Cycles in this space are long — small caps cracked 50-60% in 2018 — so take a five-to-seven-year view and remember the one line he repeats like a mantra: earnings equal stock price compounding.

Key Takeaways

Cap definitions are pure rankings: large = top 100, mid = 101-250, small = 251+.
A mid cap today can be a ₹1 lakh crore company earning ₹2,500 crore — “risky” is an outdated reflex; risk depends on business model, not size.
Many sectors exist only in small/mid cap: AMCs, wealth management, exchanges, auto ancillary, EMS, CDMO, hospitals (until recently). Large caps offer a crowded, repetitive set.
Banking is the reverse — large banks beat small ones on deposit trust and tech spend — so he under-plays banks in small/mid cap funds.
Multibaggers are recognized only in hindsight; for every one, ten fail. Don’t target them — target a compounding rate.
The arithmetic: 25% CAGR = ~10x in 10 years; 15% CAGR = ~4x in 10 years. A 15% earnings floor is his minimum filter.
Invesco runs bottom-up: ~300-stock universe, 45-50 conviction names, absolute-return focus, discipline on price.
Promoter “fire in the belly” is a core qualitative screen — beware older promoters who shift from growth to wealth preservation.
Realistic long-run return from small/mid cap funds: ~13-14%, not the 2020-24 frenzy. Lower inflation (3-4%) means 13% now equals 15-16% then in purchasing power.
Beating the index is much harder now (heavy analyst coverage, concalls, no info edge); alpha now comes from portfolio construction, not stock picking.
60-70% of a growth company’s value sits in terminal value — a narrative — so a one-or-two-year P/E can’t decide cheap vs expensive; you need the runway.
Overheating red flags: everyone’s talking about it, and price has rerated far beyond earnings growth.
Cycles are long (5-7 years); small caps fell 50-60% in 2018. Allocation is individual; don’t put money you’ll need within 5-7 years into small/mid cap.
Ideal portfolio: 8-10 funds max (3-4 categories, 2 each); over-diversifying just buys you the index at a higher fee. If forced to pick two equity categories: a midcap and a small cap fund (pure plays, 65% true-to-label).

Claude’s Take

This is a competent, low-ego practitioner interview — the kind worth listening to precisely because it refuses to be exciting. The title promises a secret to finding multibaggers; the honest answer delivered is “you can’t, so stop trying, and compound instead.” That’s the correct answer, and it’s a small act of integrity to give it on a channel that profits from people wanting the secret.

The strongest, most original section is the sector-availability argument: the observation that AMCs, exchanges, EMS, CDMO and auto ancillary simply have no large cap representative is a genuinely useful lens, and the banking counter-example shows he’s not just pattern-matching “small = good.” The valuation-as-terminal-value bit is textbook DCF, but he explains why a one-year P/E is misleading better than most.

The BS filter has two things to flag. First, this is a fund manager on a fund-house channel, and the whole episode gently funnels toward “small/mid cap funds belong in every portfolio” and “active management still earns its fee” — even as he candidly admits beating the index has gotten very hard. That admission, sitting right next to the pitch, is the tension to watch. Second, the “risk is lower than you think” framing leans hard on the long horizon and quietly under-weights that most retail investors don’t actually hold through a 50-60% drawdown — his own 2018 example. The advice is sound if you have the temperament, which is a bigger “if” than the episode lets on.

A 6: solid, honest, a couple of genuinely portable ideas, but it’s a category-marketing conversation at heart and the transcript was badly garbled, so some nuance is reconstructed rather than quoted.