What’s a Compounding Machine?
A Compounding Machine is a term I am borrowing from money manager Chuck Akre (FBR Focus Fund). He uses the term to describe the type of businesses he likes It is a business that earns an above average rate on owner’s capital (equity), with an owner/manager that has a history of acting in the best interest of all stockholders, and one that has the ability to reinvest excess cash at above average rates of return. These factors combined result in a business that can compound its economic value (and stock price) at an above average rate for a long period of time. It should come as no surprise given this strict criteria, that Akre has held shares of Berkshire Hathaway since the 1970s.
At this stage in my investing career (4 years in) my understanding of businesses/industries is limited. I have a basic understanding, and feel comfortable with, any business that uses a cash register. I am working on expanding my circle of competence. However, I do feel that I have the capacity to read what owner/managers write, listen to what they say, look at their track record, and understand what is important to him or her.
In general I am looking for a company with a Chairman or CEO that owns a significant portion of common stock so that his interests and future success is closely tied with my own, that buys into the investment philosophy pioneered by Benjamin Graham and perfected by Warren Buffett, and that is able to effectively communicate the long-term goals and objectives of the business either through annual letters, conference calls, annual meetings, television interviews, etc. In my view, combining a manager that meets these criteria with a business that produces significant free cash flow can result in a Compounding Machine.