The principle of compound interest not only drives the creation of personal wealth but propels great corporations to new heights at a sustainable rate. Here is what they have in common.
Compound interest is essentially money begetting money; it is a steady growth of capital.
Compounders achieve insane growth by leveraging competitive advantages to gain incremental market share, generating high returns on capital, and reinvesting cash flows back into the business to produce higher cumulative returns over time.
In terms of competitive advantages, compounders benefit from classic ones, including network effects, a strong culture, differentiated IP, and a compelling brand.
Regarding virtuous reinvestment cycles, companies with high ROIC demonstrate a combination of high recurring revenues, high gross margins, and low capital intensity, which generates strong free cash flow (FCF) that can then be reinvested.
Compounders also tap into underpenetrated, growing markets, but they are also aware of mirages in which companies have only short-term attraction and heat.
Moreover, compounders should be aware of earnings per share, spending cuts, and low ROIC acquisitions, as all can be indicators of companies that are not focused on long-term, sustainable growth.