First, I will not get to speak to most of the folks reading this, but if you celebrate Christmas I wish you an enjoyable holiday, hopefully surrounded by friends, family or both…

Most of us know how compounding works.  The rub is how difficult it is to apply.  Out of 10 corporate CEOs, all will tell you they are building value for the long run, but perhaps 1 or 2 actually does so.  Compounding is easy in theory and hard in practice.

Think of this post therefore as a “MoneyBall” of long-term investing. We want to get on base. Home runs don’t win the game – getting on base does.  It doesn’t matter how ugly the player is or whether he walks or singles; it matters that we get on base.

The simple math: In this spirit, Colarion recently posted to Twitter some numbers from owning an asset that grows by 12% a year for a decade:

This seems sporty, but why settle for 12% when the average US retail investor expects 15%?  Further, Bitcoin is up thousands of percent as are Dominos, Apple, etc.

The reason is there is value in consistency.  The value is not just psychological but also quantitative.

Let’s look at an average 13% return over 10 years:

$3.10 is more than $1.97.  Year 5 sank you.  For many investors, year 5 is currently taking place in fintech, SaaS, and consumer technology companies.

However nobody can make exactly 12% every year.  Getting as close as possible to this is the challenging process we undertake.   If we want 3.1 we train like base hitters Tony Gwynn and Wade Boggs.  We are reminded here that it’s no accident that Buffet and Munger filled their portfolios with banks for decades.

How to consistently “get on base”:

• Undesirable: private equity tricks – Some simply ignore the true market value, keep things marked at cost, and wait, as many private equity or venture capital concerns may do (despite an audit). This may work for a while but most see it as a trick.  Many limited partners could not have gotten liquidity at their marked value in March 2020 when they wanted it.  Allocators therefore typically request over 15% compensation for the illiquidity.

• A little less bad: market timing – Another way is to try to sell at the top.  This can make sense when a thesis changes, but when we do this, we generally pay a marginal 20-40% depending on holding period, and this makes the 3.1 more challenging on an after-tax basis.

• A little better still: core and noncore – Some folks look for quality companies, own them in some size, and use a combination of selling, plus options or other hedges to try to protect principal in bear markets. While this requires expertise and discipline, it is a common practice and can work.

• Best: a refined core – Perhaps a step further than the above is to try to find unusually consistent companies. Consider an industry that began around the time of the pyramids, has more data and transparency than any other (no serious bank reports “adjusted” revenues or EBTIDA), and has a capital base that can compound on itself better than an asset-light company that is only as good as its latest product.  Hidden below the surface are scores of consistent little banks that most have never heard of, like First National Bank of Alaska (FBAK), which actually paid a large special dividend just after the financial crisis.

When we can find outliers in this industry (banking), by spending time speaking directly to managements and knowing the “tells,” then we have a good shot at something we can hold for a decade – something like that 3.1x.

A quick example – most well-run mid-sized banks were once well-run smaller banks, with Nicolet and Pinnacle two examples among perhaps 50 of the 700+ publicly traded banks to blow out the 12% compounding rule.

Pinnacle and Nicolet quintupled because of results rather than stories and multiple expansion to 20x sales..

Happy Holidays, and may your next Christmas include a year of unexciting compounding in your portfolio.