# Compounding with or without the Compounders...

### Mathematically possible at 24% a year or maybe not

*One of my friend asked incredulously on our 24% per year target… We did not attempt to answer during our chat as it is incredibly simple in explanation but confounding in practise. *

*We are sure that we will fall short on the target but anything slightly lesser is fine for us. *

*To the people who understand finance, they will think that any promise of 24% per year is a fraud! The usual response is “That is impossible to achieve!” Even Warren Buffett, the most famed investor in the world average 30% annually in his initial years and 20% thereafter. *

*To the people who do not understand finance, they will think that they could easily do it since the market is giving them 50 - 100% per year in 2020 and 2021. Compounding 24% per year seems like an underachieving exercise. *

*For us, the question is let us aim a bit higher and maybe fall short. *

*Or the more pertinent question is how do we mathematically hit the annual return of 24%? *

*We think 24% stuck in our head due to the rule of 72. It is nice to be able to double your money every 3 years. But technically, the percentage return could be any number. *

The answer to __% per year compounding lies in 3 assumptions:

The ability to buy a company at X% of discount

The share price will be valued at fair value in Y number of years

The growth of the company will be Z% for the Y number of years

If we can get this 3 assumptions right, we could be close to the magical 24%!

For us

X = 50% discount,

Y = 5 Years,

and Z = 8% growth.

Do your math* and you will know what we mean!

The general aim is to buy fifty cents on a dollar worth of value. If we are able to ascertain that the company might be fairly valued in 5 years time (due to special situation or general recognition of the potential of the company) and the company continue to grow at 8% per year, we would magically reached the 24% annual return!

Mathematically, the most common mistake that investor make is that they

bought the company with no discount (X = 0%)

do not know when the company would be fairly valued (Y=Infinity?)

had assumed too high a growth for the company (Z > 8%?)

In common investing framework, investor usually

buy without a margin of safety (X<0%),

do not have a catalyst to determine the time period Y,

assumed a too high rate of growth Z% which could not be delivered.

It all sound simple on paper (investing is really simple) but it ain’t an easy practise.

Getting to a successful investment requires

estimating the margin of safety X% (depends on your valuation skill),

estimating the time period Y (depends on your business acumen),

estimating the growth rate Z% (depends on the understanding of the industry).

In Special Situation investing (Special Portfolio), the margin of safety of X% and a time period Y is clearer. The problem is the growth rate Z%. Since it is a special situation we would not require growth to realise the value and we can safely assume that Z = 0%.

In Unrecognised Growth investing (Super Portfolio), the assumed growth rate Z% and time period Y needs to be reasonable by industry standards. By accepting a lower margin of safety X, we would be able to get a chance to buy at a reasonable expectation.

In Statistical investing (Statistical Portfolio), we are trying to assemble a portfolio of companies which has various X%, Y time period and Z% which on average should achieve 24% in return over time. The ability to accurately assemble such a portfolio become key to generating the required return.

Overall, coupled with some luck we should be getting close to our 24% annual return using a variety of X,Y and Z.

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*in excel, n=5, PV= - 0.5, FV = 1.08^5, =rate() and you will get 24%!