The Consistent Compounding Formula
In this book, the author elaborates on the key elements necessary for crushing risk to generate steady and healthy returns from equities in India. Their approach is to buy clean, well-managed Indian companies selling essential products behind very high barriers to entry. They call this approach to investing Consistent Compounding, and have seen, both in theory and in practice, that it works. This approach has three key elements—
- Credible Accounting
- Competitive Advantage
- Capital Allocation
They are the foundational pillars of Marcellus’s investment philosophy, which will help investors generate healthy returns without taking additional risk (or loading up on beta).
The first pillar, Credible Accounting, uses a set of forensic accounting ratios and techniques to identify companies with the least accounting risk and the highest reliability of reported financial statements.
The second pillar, Competitive Advantage, is the search for companies that possess strong and durable pricing power, enabling them to be leaders in their markets and consistently earn returns higher than their cost of capital. This mitigates their revenue and profit risk.
The third pillar, Capital Allocation, is about finding companies that make the best use of their excess returns (the difference between the return on capital and cost of capital, akin to free cash flow) to grow their business and deepen their competitive advantages.
Knowing what stocks to buy using the three pillars is the ‘Consistent Compounding Formula’
In the first part of the book, the author discusses the Consistent Compounding Formula to understand ‘what to buy'. Then, in the later part, they discuss ‘when to buy' and focus on two key areas that regularly confound investors—the timing of stock purchases (or sales) and the valuations at which to buy (or sell) them. But, before they dive into these topics, let us also understand what this book is not about in the next section.