The Power Of Compounding

The Power of compounding keeps surprising me every now and then, even though I am familiar with it for quite a long time. Today, while calculating the returns made by Page Industries (The franchise owners of Jockey in India) in last 4 years, I realized that it has gone up by more than 5 times (from 800+ to 4300+). What intrigued me most was the fact that this share was a costly share even four years back. It used to trade at 25+ pe even in 2009. Of course, 25 pe is much lesser than the 40 pe at which it trades now, but the valuation expansion because of pe re-rating is just about 50%. The remaining 4x expansion in the valuation has actually come through profit growth.

As I have been tracking this stock from 2009 onwards, I knew that this stock was never one of those high fliers who grow their profits by 70-80%. It was much more of a compounding story. So, I decided to look back at the compounded annual growth rate (CAGR) in the profit of this company. For the last 3 years the profit CAGR of this company is 42%, while for the last 5 years it stands at 37%. I realized that the company might have grown its profit by an average CAGR of 40% for last 4 years. This 40% profit growth is definitely not a very high flier number, but done for 4 years consistently can take the profit to 4x in 4 years. And, that is what explains the rise in the price of Page Industries share.

Sometimes, when a lot of hype is created around a stock, we pay attention only to the hype and consider that to be the only reason for the rise. But, a little careful analysis can throw such insights like "A company growing its profit by 40% for 4 years can rise by 4x without any hype attached to it". Whether the market discovers such stocks or not, by sheer power of compounding and consistency they can be multi-baggers.

The implication of such insights for our portfolio of stocks is quite profound. If we can find a stock that can consistently grow its profit by 40% CAGR, we have a 4 bagger in 4 years without any pe rerating. This means that such shares should not be sold even if they become slightly costly in the near term. This also reaffirms my belief in shares like Ajanta Pharma (49% profit CAGR in the last three years), Kaveri Seeds (67% profit CAGR in the last three years), and Cera Sanitryware (34% profit CAGR in the last 3 years). These are horses for quite a long run and should not be sold even if they become slightly costly in the near term (they are far from being costly at current valuations). Of course, past performance is no guarantee of the future performance, but if they continue to perform like they have been doing till now, investing in them could be quite satisfying.