Two Minutes Reading for the Smart Investing Strategy
Most investors are told: “the higher the price you pay, the lower your future return.” True—but not the full story. In some cases, buying a great business that can keep growing is far more important than worrying about whether you’re paying 20x or 30x earnings.
Compounding Is the Real Magic ✨
The heart of good investing is finding businesses that can reinvest their profits at high returns year after year. If a company earns 18% on every dollar it reinvests, the power of compounding can make up for almost any temporary drop in valuation.
For example, imagine a business earning 18% returns and reinvesting everything for 30 years. Even if its stock gets cut in half at the end, your annual return may still be around 14%—better than the long-term market average.
Not All Growth Is Equal 📈 vs 📉
Here’s the catch: growth only creates value if returns on capital are above the cost of capital. If a company keeps expanding but only earns 6% while money costs 8%, that growth destroys value. Bigger isn’t always better.
Think of Costco vs. LVMH (Louis Vuitton). Costco turns over its capital quickly, compounding wealth faster even at lower margins. LVMH earns high margins but needs heavy spending and marketing to keep growing. Both can be strong investments—but understanding how growth happens matters more than just looking at profits.
Dividends Are Not Always the Answer 💸
Many investors love “dividend daddies”—companies that pay out most profits. But if those companies can’t reinvest at good rates, the investor’s return is capped. Over decades, reinvestment at high returns usually beats cash payouts.
For instance, a company that pays out everything at 6% return might only deliver 5% annually over 30 years. Compare that to a compounding business reinvesting at 18%—it could grow your money more than 10x.
The Takeaway for Investors 🧭
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Focus less on valuation multiples. Paying 25x earnings for a compounding machine can be smarter than 10x for a low-growth stock.
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Look for reinvestment opportunities. Can the business put money to work at high returns?
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Avoid value-destructive growth. Growth below the cost of capital hurts shareholders.
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Stay patient. Compounding takes decades. Only a handful of firms (maybe 4% of the market) have created most of the long-term wealth.
Charlie Munger put it simply: “If a business earns 18% return on capital for 20–30 years, even if you pay a high price, you’ll end up with one hell of a result.”
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