Harnessing Compounding Through Long-Term Ownership of Quality Businesses
My investment philosophy centers on harnessing compounding through long-term ownership. As an individual investor, my greatest edge is time—the ability to hold exceptional businesses for years or decades, letting compound growth create substantial wealth.
I achieve this by investing in quality compounders—businesses that consistently reinvest earnings at high returns on invested capital (ROIC), growing intrinsic value internally through predictable free cash flow (FCF) growth. These are businesses that act as wealth-building engines, like Visa, where network effects drive FCF growth that can be reinvested at attractive returns.
While I focus primarily on compounders with long reinvestment runways, I won't ignore quality businesses that return capital to shareholders when done wisely and at attractive prices.
My framework assesses three critical areas to identify businesses worth owning for the long haul while avoiding costly mistakes.
Identify businesses that can predictably compound value through disciplined capital allocation and sustainable competitive advantages.
Understand what could derail a company's compounding ability and maintain appropriate margins of safety.
Determine fair valuations using both relative metrics and discounted cash flow analysis as a sense-making tool.
I seek businesses that can predictably compound value over time through disciplined capital allocation and sustainable competitive advantages.
I prioritize structural moats like regulatory protections and scarce assets, as well as competitive moats like network effects, high switching costs, and irreplaceable brands. These barriers ensure pricing power, customer loyalty, and resilience.
This is perhaps the most critical factor. Management must be exceptional stewards of capital, demonstrating the discipline to reinvest only when returns are attractive and the judgment to recognize when growth opportunities are exhausted. I want to see evidence of consistently high ROIC over time, not just current metrics.
True compounders generate growing free cash flows that provide fuel for reinvestment. I look for businesses where I can reasonably project FCF growth based on their competitive position, simple business models, and revenue streams that provide visibility such as recurring revenue, long-term contracts, or subscription models.
Current ROIC matters, but sustainability matters more. I study whether the business can maintain high returns as it scales, examining whether the moat strengthens or weakens with size, and whether incremental investments generate similar returns to historical ones.
Strong margins signal pricing power and cost discipline while providing a buffer during downturns and fuel for reinvestment. I look for a track record of stable or expanding margins that demonstrate consistent execution.
I'm drawn to businesses—especially asset-light ones—where revenue growth outpaces cost growth, creating expanding margins and accelerating cash flow generation that fuels further reinvestment.
I evaluate how much capital can be deployed at attractive returns and for how long. The best compounders have years or decades of profitable reinvestment opportunities ahead of them.
Conservative debt levels and strong cash generation reflect management's commitment to financial strength, providing resilience in downturns and flexibility to seize opportunities.
Risk isn't volatility—it's the potential for my investment thesis to break. I need to understand what could derail a company's compounding ability. Understanding risks upfront helps me stay rational during market volatility, focusing on long-term fundamentals rather than short-term noise.
I monitor three key categories of risk, asking myself specific questions about each potential investment:
Can new entrants easily replicate this business model? Is the company vulnerable to pricing pressure or disruptive innovation? I look for businesses where competitive advantages are structural and hard to erode, not just temporary market positions.
Does the company carry excessive debt that could constrain flexibility during downturns? Is it vulnerable to regulatory changes or cyclical swings? I prefer businesses with strong balance sheets and stable, predictable cash flows that aren't dependent on economic cycles.
Is the business overly dependent on a key executive or founder? Are there governance concerns or signs of erratic capital allocation? I want management teams with proven track records and alignment with long-term shareholder interests.
While I start with quality, valuation ultimately determines returns. A wonderful company at a fair price will outperform a mediocre one bought cheaply, but even the best business can be a poor investment if overpriced.
I monitor metrics like P/E, EV/EBITDA, and P/FCF, comparing them to the company's historical multiples, current performance, and industry peers. This helps gauge whether the market is pricing in excessive optimism or unwarranted pessimism.
I create relatively detailed DCF models that serve two key purposes. First, they force me to translate my narrative about the business into numbers—if I can't construct sensible assumptions about cash flows, growth, and margins, it signals my understanding isn't deep enough or the business isn't as predictable as I thought.
Second, the model gives me a general idea of where the stock is trading relative to my assumptions. I recognize the significant limitations of DCF analysis—small changes in assumptions can dramatically alter results—but the exercise helps me understand whether the current price requires assumptions I don't believe are sustainable.
This approach leverages the individual investor's unique advantage: the ability to invest for the long term. While institutions chase quarterly performance, I can hold exceptional businesses for years, letting compounding work through quality businesses that reinvest at high ROIC.
The psychological benefits are equally important. This philosophy provides discipline while demanding patience, recognizing that overpaying even for quality businesses impacts returns. The framework helps me make pragmatic decisions and stay rational during market volatility, focusing on long-term fundamentals rather than short-term noise.
Market volatility becomes opportunity, not anxiety. When markets pull back, I view it as a chance to buy quality businesses at better prices. For companies I own but perceive as overvalued, I'll avoid adding but continue holding, letting the business grow into its valuation.
The framework ensures discipline by filtering out mediocre businesses, avoiding overpayment, and preparing for risks. It's flexible enough to adapt across industries but maintains consistently high standards.
Decisions like when to sell require pragmatism. Selling becomes thesis-driven, not price-driven. I sell only when the fundamental investment thesis changes: moat deterioration, capital allocation breakdown, predictability loss, or complexity creep.
Most importantly, this framework leverages a fundamental truth about investing: value is created through businesses that compound cash flows over time, and not through market speculation. This framework helps me identify exactly those businesses.
This philosophy is my north star, refined through experience and inevitable mistakes. I've misjudged businesses, overpaid for quality, and held positions too long. But each mistake has strengthened the framework and reinforced why discipline matters.
The framework will continue evolving as I learn, but its essence remains constant: seek quality businesses with durable moats and disciplined management, focus on true compounders with long reinvestment runways, manage risks with clarity and maintain a margin of safety, and pay a fair price while being patient.
This isn't just an investment strategy—it's a mindset that aligns with how wealth is built over time.
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