COMPOUNDING MACHINES

“The ideal business is one that earns very high returns on capital and that keeps using lots of capital at those high returns. That becomes a compounding machine.” Warren Buffett

“We focus effort on the rare long-term high compounders.” Li Lu

"A compounder is a competitively advantaged business that earns superior returns on invested capital. As cash earnings are reinvested back into the business, the value of the business grows year after year compounding our investment. If we buy at a discount to what we believe the business is worth, we will benefit twofold: by the growth of the intrinsic value and the market correction for the discount. There are two key variables when we evaluate a compounder: the competitive advantage of the business and the discrepancy between intrinsic value and quoted price. Competitive advantage can be fluid and fleeting, thus having a deliberate way to qualify this attribute is critical to success in this category." Christopher Begg

“I expect everyone has a slightly different understanding of what the term ‘compounder’ means, but generally it describes a company that can grow or compound earnings by reinvesting capital (not by raising external capital). Compounders are likely to share some or all of the following characteristics: High returns on capital; Profitable (on an underlying, not necessarily reported basis); Large Total Addressable Markets (“TAMs”); A growing competitive advantage; A strong culture characterised by humility and adaptability (essential to overcome growth pains); A founder who likely embodies these values; And predictable, better still, recurring revenues. This is not a definitive list, and different companies will have these qualities in different quantities, but it gives a sense of what I am driving towards. Google most certainly is a compounder; Deutsche Bank probably is not.” Robert Vinall

“The compounding machine stocks are the Holy Grail of investment.” Mohnish Pabrai

“At our firm we spend nearly every waking hour trying to identify what we refer to as 'compounding machines.'” Chuck Akre

“To his son, [Shelby] Davis passed along his infectious passion for owning shares in carefully chosen companies (he called them ‘compounding machines’), his conviction that owning the best compounding machines would lead to unimagined rewards, his distrust of unnecessary spending (why waste money they could be invested?), and his workaholic tendencies.” The Davis Dynasty

“What we learned is that if you buy a good and sustainable business, then over time the return of that business will do the natural compounding for you.” William Browne

“We want to buy businesses that are compounding machines. We want to build wealth for a generation.” Chris Davis

“We can do better with the compounding businesses these days - and they are much less stressful.” Nick Sleep

“We attribute our low-turnover approach to our conviction that the reason for investing in quoted securities is to participate in the compounding of value that certain businesses can generate for their owners over time. Most businesses do not (in our view, at least) promise to be distinguished long-term compounders, although they may have cyclical moments of distinction in the stock market. If we for some reason made it our business to invest in most businesses, perhaps on the theory that every dog has its day, we would no doubt feel compelled to trade more frequently. As it happens, we do not aspire to own every stock that’s going to outperform the market tomorrow, or in the next quarter, or even for the next year or three. We seek only to own stocks that will compound in value over the years.” Andy Brown

“Every company we have, they are compounders – they are working for you whilst you’re sleeping. You don’t need to do a lot. You don’t need to change horses all the time. You just ride the horse you’re on and in the long run they compound for you. It makes your life simple. Simplicity is very powerful.” Lei Zhang

“We expect most or our return to come from compounding of intrinsic value rather than a return to intrinsic value.” Ira Rothberg

“Discounts to asset value are not enough, in the long run you need earnings to be able to sustain and nurture the corporate values.” Peter Cundill

"The three areas of analysis – business, management, and reinvestment – are the key components of what we call our ‘three-legged stool.’ When we find a business that satisfies all three of our requirements, we refer to it as a ‘compounding machine,’ and we seek to purchase shares at a modest valuation." Chuck Akre

“Aligning ourselves with these types of businesses—those we consider compounding machines—has enabled us to generate compelling returns for clients over more than three decades despite macro and market headwinds coming and going along the way.” Dan Davidowitz

“I think it is always better to buy compounders, it’s always better to buy growth. If you are buying an asset because it’s cheap your upside is limited. Buying cheap assets in my opinion, it’s not the name of the game. You want to get to high growth, where intrinsic value increases over time." Mohnish Pabrai

“Compounders are generally market leaders, with high barriers to entry and high returns on capital, whose intrinsic values are growing at a healthy rate. The reason they can be mis-priced is typically a function of time horizon. When investor’s don’t focus on the distant compounding merit of a great business, they may not assign that merit a fair value.” Christopher Begg

“Our strategy is to own high quality, modestly valued business over many years, to take advantage of the power of compounding as earnings grow. To do that successfully only works if we avoid mistakes – unforced errors – that interrupt the power of compounding.” Ira Rothberg

"From our vantage point, the debate around what is value (e.g. the index, the factor, sectors) versus growth loses sight of our aim to identify compounders of value." Dan Loeb

"Our preference remains for those companies that we call the 'continuing compounders' — businesses that, in our view, offer financial strength , earnings stability, & compound growth." Rajiv Jain

“If you’re going to own a company for a long time, the earnings it generates today will be a small component of the eventual return. Much more important will be how those earnings can be reinvested over time to build value. When companies with positive compounding characteristics become available at really attractive prices, we’ll hope to take advantage.” Chris Davis

“A penny doubled every day for a month turns into $10.7m, that’s the effect of compounding. When we are looking for businesses that can do this we are looking for businesses that can reinvest their free cash flow back in the business to continue to earn above average rates of return on that capital and therefore compound the owners capital.” Chuck Akre [on compounding machines]

"What I have learnt is don’t sell the compounders when they get fully priced or they get over-priced. Only sell the compounders when its absolutely obvious to you that it is egregiously priced. The big money is in riding the compounders but you have to try to get in at a reasonable valuation and you have to be right on the fact they are compounders. It’s a forgiving business, so you can be wrong quite a few times and still be okay. It was a difficult lesson for a cheapskate like me. It was a very difficult lesson for Warren and Charlie. I think they learnt the lesson from See’s Candy, that was a seminal lesson for them." Mohnish Pabrai

“If you’re really lucky enough to really find one of those long-term compounders, all you have to do is really to own them for the longest period of time. Now, it helps when you really buy them at the time when they happen to be traded at a discount to their intrinsic value so that if you were wrong about them, you won’t lose money, and if you’re right, you have more returns over time.” Li Lu

“Some of our biggest mistakes have been in selling down positions in great businesses when we thought they were fairly valued, or even a bit overvalued. In our experience, compounders tend to keep compounding, so we’re slow to sell unless something in the business or company has fundamentally changed or if the valuation has just become extreme." Peter Keefe

“If we have identified a great business, a compounding machine that we’ve purchased well, we want not to interrupt that compounding unnecessarily by curtailing it with a sell target. We want these businesses to continue to compound and we want to own that as long as they continue to be exceptional. So no sell targets, only buy targets.” John Neff, Akre

“There is virtually no price at which a great compounder, properly identified, cannot be bought.” Robert Vinall

“The first take away is that nearly all compounders have high returns on capital and high returns on equity. Capitalism is a brutal place and if you don't have the comparative advantage to protect your high returns new entrants are going to come in and eat away that competitive advantage. The fact a company sustains high returns is a signal (it might be a compounder). The necessary condition is the competitive advantage, while the high return on equity or capital is typically the output. All compounders tend to have high returns on capital but not all companies with high returns on capital are compounders. That’s important because it means you can’t just run a screen and buy. There is real critical thought and judgement required.

The second takeaway, is that P/E multiples that are optically expensive are often very cheap prices for compounders. No matter how many decimal places you go out to in excel, you're not going to find critical judgement in a spreadsheet. So a clear understanding of a compounders sources of competitive advantage is critical for owning one for long periods of time. You have to have a competitive advantage and that has to be rock solid - it has to exist and be sustainable. Oftentimes for compounders, you need low total addressable market penetration, ideally in a very large total addressable market and even more ideally, in one that is growing. This is often an enabler of reinvesting free cash flow at high incremental returns on each dollar invested. The very act of redeploying this capital back in the business at higher returns not only enables the compounding but it also serves to improve, expand and extend the business’ competitive advantages if allocated properly.” Jeff Mueller

"With an outstanding re-investor at the helm, even an ordinary business can become a remarkable compounding machine. There are abundant examples, including of course Berkshire Hathaway, which began its compounding journey as a struggling textile mill." Chuck Akre

"The lens through which I look at businesses has changed. Compounder and multi-baggers are in focus. 50-cent dollar bills are out of focus." Mohnish Pabrai