Big name financial gurus like Dan Loeb and Warren Buffet make their money with smart investments, such as companies that are considered “value compounders.” A value compounder is a long-standing, stable business that can earn investors a ton over time. They usually have things like franchises, conservative balance sheets, and positive free cash flow. What they lack in investment excitement, they make up for by being a sure bet that provides value over time.
Loeb in particular has had great luck with these sorts of investments. His Third Point Fund, which has been around for 20 years, posted 21% annualized returns over its lifetime, compared to a 9% annualized return for the S&P 500. Third Point is up 4.9% so far this year, and Loeb estimates that the company has generated $12 billion in trading profits for its clients.
His secret? Value compounders, in large part. “Over the past few years, we have found investment opportunities in several companies that share simple, common characteristics: talented management teams, strong and growing free cash flows, and a proven track record of smart capital allocation that drives significant increases of intrinsic value per share,” Loeb wrote to his clients.
Value compounders may not have the excitement of more volatile investments, but their long term quality ensures that they will pay out in the end. Some examples include Fundsmith, Kennox, and Finsbury Growth & Income. These, according to recent research, give 6-7% return a year, though they tend to be much more volatile in the short term.
The holy grail for investors, of course, is a company whose stock is both cheap and destined to rise in value exponentially, due in large part to the sorts of qualities compounders possess. These investments can be hard to find, but they do exist.
It’s also worth noting that a value compounder may not be the most obvious company. In Warren Buffett’s Tap Dancing to Work, he writes about his frustration that he was able to buy Disney stock at a low price in 1966–31 cents–and that it had only risen to 48 cents in 1967 when he sold his shares. By 1996, when Buffett no longer had an interest in the company, shares had risen to $65. That’s a compound of 18.4% per year.
But because Buffett sold when he did, he was able to go on to invest in his own Berkshire Hathaway, which grew over 500x during the period Disney grew only 135x. So by focusing his energies on an undervalued company, he was actually able to come out ahead.
Accurately determining which companies will be value compounders isn’t an exact science by any means, but it does ensure that investors have the opportunity to hit it big with winning investments like those of Buffett and Loeb.