In June of 2015, shares in Objective Corp (ASX:OCL) — a much under-recognised compounding machine that provides software to government and enterprise customers — hit $2 per share. It was a record high following a staggering rally from just 20c a few years earlier. 

This ‘ten-bagger’ was certainly assisted by improving revenue and gross profits, both of which had grown 25% over the previous few years. But it was a market ‘re-rate’ that did the heavy lifting: the average annual P/E ratio grew from 11 to 30 between 2012 and 2015. 

That’s not to take away anything from those who invested back then — a P/E of 11 was ludicrous for a business that was generating increasing levels of free cash flow while still investing heavily into R&D and aggressively buying back shares.

Value can sit in plain sight for ages before the wider market finally cottons on, especially for small-caps that more easily fly under the radar.

With shares today sitting north of $13 each, anyone who invested in the company at $2/share in 2015 has been clearly vindicated. Not only have shareholders scored a compound annual capital gain of more than 30%pa, but dividends would have repaid a quarter of your purchase price.

It looks easy in hindsight, though it was anything but. Consider the following, which tends to be true for most long-term compounders.

  • It’s not easy for value-focused investors to buy shares that have already increased 10x in very short order, especially where the market multiple sits significantly above the average.
  • After buying at $2, you’d have seen shares drop as much as 30% lower and spend almost two years underwater.
  • When shares did eventually start to push higher again, the temptation to take profits would have been incredibly difficult to resist. In 2021, you could have cashed out at $10 and pocketed a 5x return — and with the P/E then at 50x it would have seemed more than justified.
  • Throughout the journey, shares experienced multiple pull-backs of more than 20%, and are presently down 40% from the 2021 high.

The gains for Objective Corp shareholders may be eye-watering, but they have been hard fought.

While such examples are the exception to the rule, they are perhaps more common than you might think — Pro Medicus (ASX:PME), Polynovo (ASX:PNV), Nanosonics (ASX:AD8), Audinate (ASX:AD8), Altium (ASX:ALU) are just a few that spring to mind. All virtual king-makers that went from relative small-cap obscurity to industry leaders valued at hundreds of millions (and in some cases billions) of dollars with lots of potential for further growth.

While we can always lament having missed out on monster multi-year returns (if indeed you did, there’s more than a few Strawman members who caught plenty of the upside), there should be great solace in knowing that many eventual 10-baggers are likely sitting right under our noses.

And here the story of Objective Corp and its peers can be instructive.

  • All of these companies had successfully commercialised products and were generating growing sales. Several were already profitable. Investors who bought years ago weren’t speculating just on pure blue-sky potential.
  • Share prices a decade ago seem insanely cheap from today’s vantage point, but were actually at or near record highs at the time. 
  • The market was often very slow to react to demonstrated business progress. Painful and protracted drawdowns were common.
  • Even accounting for the explosive revenue growth in these companies, share prices often ran ahead of what was reasonable. Of course, the extent and duration that the market overshot things was impossible to predict. 
  • All of these companies had (and continue to have) a big focus on R&D and a capacity to reinvest earnings at high rates of return.
  • All would often fall short of analyst forecasts, and most had to suffer through various and not-insignificant business setbacks.

The bottom line is that these opportunities are never obvious, they take years to play out, and give rise to many a sleepless night. Which is why, if you hope to catch a baby giant, you need to do your research, build conviction, practice extreme patience, and react with equanimity to (often extreme) price volatility.

Easier said than done, but well worth the effort.

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