Monday, August 14, 2017

The '26% Secret' to Buffett's First Billion

'How old were you when you read Buffett for the first time?'

The question from my American niece almost embarrassed me. All of seventeen, she's already read half a dozen books on the legend.

I didn't start reading Buffett until I was nearly twenty-two...

But I draw solace from the fact that one of Buffett's best 'cloners' also started relatively late.

Mohnish Pabrai, who won the 2008 auction for a lunch date with Buffett, has a commendable track record in value investing. He attributes all his success to shamefully 'cloning' Buffett's strategies...which he only started learning when he was thirty!

Pabrai's best move, I think, was picking Buffett's most potent strategy and cloning it diligently. Pabrai calls it 'the magic of 26%'. That's the rate his portfolio compounded from 1995 to 2014. And as Prabrai often explains in his speeches, it was the magic of 26% that earned Buffett his first billion.

Now, there is a bit of math in this. But stay with me; it could help you earn your first billion.

'The magic of 26%' refers to the rate at which a company should grow its earnings year after year. In other words, your job as a stock picker is to focus on finding companies that are growing their earnings at 26% per annum.

With that and without having to do anything else, you could have 10-bagger (900% returns) in just ten years. And a 100-bagger (9,900% returns) at the end of twenty years.

This is because, if you compound money at 26% per annum, it doubles in exactly three years.

But make no mistake. Finding companies that can grow earnings at 26% per year over the next decade is not easy. Out of every five companies growing at this pace now, maybe one or two will be able keep it up until the end of the decade.

That means you need to find at least five 26% compounders to get hold of the one or two that will truly compound your wealth till the end of the decade.

Keep in mind these 26% returns aren't likely to remain sacrosanct...unless the company's management is a brilliant capital allocator, the business has a strong moat to keep competition at bay, and the demand for its products or services remains inelastic.

If that sounds easy, reckon this...

Of all BSE 500 companies, only 42 have managed to grow their earnings at a CAGR of 26% or more over the past ten years. However, most of them have had very inconsistent shareholder returns (return on equity).

So I looked for stocks that have seen earnings growth of 26% or more in the past ten years and have had no less than a 15% return on equity in each of those years.

Guess how many stocks that yielded...

All of THREE. Ajanta Pharma, Godrej Consumer Products, and HDFC Bank

Now before you rush to buy these stocks, let me warn you: Just because these companies have witnessed phenomenal growth and consistently superior ROEs in the past, that does not guarantee they will in the future. And you certainly can't turn a blind eye to valuations.

What does this mean?

It means you must be forward looking in your search for the magic of 26%.

It means you need to look for companies that will become the Ajanta Pharma, Godrej Consumer Products, and HDFC Bank of 2027.

But don't worry if, like me, you didn't start your value investing journey in your teens.The idea is to find couple of strong fundamental stocks that will grow at 26% per year. This will easily help you make your first million, if not billion, in just a decade or two!  
Happy Investing ...

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