The power of slow compounding

I really love compounding and even more the power of slow compounding!

As many of you know, there is a legend that Albert Einstein said the following:

Compound interest is the eighth wonder of the world.
He who understands it, earns it; he who doesn’t, pays it.

And I think we all get this as dividend growth investors, because compounding is the magic that lifts us towards financial independence.

This is also the reason why dividend reinvestment is so important, because it only fastens the growth of our snowball.

But this is actually not what I want to talk about today.

Because not that long ago I saw a brief interview of Chamath Palihapitiya and he started talking about the power of slow compounding.

This is what actually inspired me to share my thoughts and how it shapes my thinking regarding being a dividend growth investor.


What is slow compounding?

Slow compounding is understood as the time it takes to build a great business and accumulate capital.

The narrative is the following:

The quicker it is to make fast money and grow as a company,
the easier it to lose it all again at the same speed.

Hence, if you build a company which is very successful in just 2 years then that’s considered fast compounding. If you build a company in for instance 8 years then that’s considered slow compounding.

The perceived downside of making money fast is that your brain get’s wired into short term thinking instead of long-term thinking.

Hence, this is where slow compounding comes in.

It takes time to solve very complex unmet consumer needs with innovative and complex solutions. S

It can therefore easily take 8 to 10 years while accumulating for instance 20% to 30% growth over such time. And that’s why long-term thinking is so important.

Long-term thinking allows you to be more considerate and strategic about your next steps to build an empire out of your business.

A perfect example of this is Amazon.

It took Amazon many years to get where it is now. It was not a business that was build over night, but actually over the last 2 decades.

And the fun fact is that there was never really hypergrowth with 100% or more during that period. However, it did became the most successful company we know today.

And why?

Because It’s very hard to replicate what Amazon has built. Their products are very complex and it costs a lot of capital to try and achieve the same.

That’s why only a company like Microsoft can come close even a little bit when it comes to for instance their AWS cloud services.

Another example is American Railways from Berkshire Hathaway.

They can hardly be disrupted technologically. As you know, goods still need to be shipped from the port to a city.

But don’t be mistaken, because Innovation is happening though!

They have been doubling the trains and increasing the height of the tunnels. They can now suddenly process twice as many goods.

But when you think about fast compounding, then in that case Zoom is a really great example.

It literally saw rapid growth over night during the pandemic due to some features it has built that resonated a lot with their consumers.

But those features are already copied by their competitors Google and Microsoft. Hence, from that point of view Zoom already lost it’s uniqueness.

And now it is in a position that it really needs to start long-term thinking, but the question is if this company has trained their muscles to be able to that.

Because if Zoom doesn’t build out their value proposition and product-lines, then it might lose most of their market share just as easily and fast again.

Why I like slow compounding

As you can guess already, I like slow compounding.

And these are my main reasons for it:

Firstly, it is much easier to follow and track those companies. I really don’t need to worry so much about their quarterly earnings.

It typically means that I need to initially study their mission, long-term strategy and execution track record very well. But after that I can be more in monitoring mode.

This saves time and allows me to own up to 40 companies. Otherwise this would just be impossible.

Secondly and as mentioned before, slow compounding companies are typically developing complex products to complex needs. This means that it’s hard for their competition to replicate and steal market share.

This is what I like, because it effectively means that such companies have strong moats. It also means that there is some customer stickiness to their products.

Switching costs for consumers are also often high as a result.

As an example, you can say what you want about SAP. But it’s so damn hard to steal market share from them!

Thirdly, it is so much easier to spot when a business is in decline.

Just take good old IBM as an example. They have already declining revenues and profits for the last 10 years.

But it’s just not easy to wipe them out over night. They have build their empire in slow compounding mode for over almost a century.

The same applies to Intel Corporation.

And this is great, because it gives us as investors very early and many warning signals.

This allows us to make more considerate decisions and we can decide to sell our shares with a reduced risk of losing all our money.

Lastly, it requires long-term thinking which wires the brain to less volatile behavior. I don’t need CEO’s that are thinking only short term due to external market pressures.

It’s more important that they are focused on further developing their product-lines and expanding their market shares.

I want them to build business that last, because the result of that should be a lot of shareholder wealth distribution in the form of dividends.


All good now, but how does it shape my thinking as a dividend growth investor?

Why I embrace it as a long-term dividend growth investor

I’m now paying much more attention to this aspect of slow compounding when I’m analyzing companies now that I’m aware of it.

I want companies in my portfolio that are growing very sustainably and building strong moats that are hard to beat.

That’s why I’m currently much more looking at their product portfolio’s compared to what I might have done in the past.

And this awareness has also given me more business knowledge about those companies. Therefore I feel much more comfortable with the companies that I own.

Having said that, I do believe that almost all the companies in my portfolio are already slow compounders.

It’s just that I feel much more confident about myself and my investment strategy.

In the past I might have been quickly jealous about growth investors that were making a quick buck on a certain hyper growth stock like Zoom.

This is not the case anymore. My fear of missing out is almost gone.

This is why I’m now fully embracing slow compounding as a core to my philosophy.

I would take 15% annual compounding over the next 20 years anytime, instead of a one-off 100% and potential mediocre performance afterwards.

Long-term thinking is what I need and companies that are built to last is what I want.

Yours Truly,

European Dividend Growth Investor


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Disclaimer

I’m not a certified financial planner/advisor nor a certified financial analyst nor an economist nor a CPA nor an accountant nor a lawyer. I’m not a finance professional through formal education. I’m a person who believes and takes pride in a sense of freedom, satisfaction, fulfillment and empowerment that I get from being financially competent and being conscious managing my personal money. The contents on this blog are for informational and entertainment purposes only and does not constitute financial, accounting, or legal advice. I can’t promise that the information shared on my blog is appropriate for you or anyone else. By reading this blog, you agree to hold me harmless from any ramifications, financial or otherwise, that occur to you as a result of acting on information provided on this blog.

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European DGI

It's my desire to retire early via Dividend Growth Investing as a passive income stream. This is not easy and especially when living in Europe. That's why I started this blog and share my journey: to give you a European perspective.
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LRezny
LRezny
3 months ago

Excellent post. I have very similar investing philosophy. But I have to say, for this to work, you have to have above average income or or you have to be very young (and wise and patient, what a rare combination 🙂 ). Personally, I behave risky regarding earning income from sidehustles etc., which I then invest conservatively. I do not need another layer of stress in life in the form of risky companies in my portfolio.

Dividend Power
3 months ago

I love the power of compounding.

MyFinancialShape
2 months ago

Hi Enjoyed reading. The compound effect always surprises me, over and over again. It’s working on so many sides. In businesses etc, Even when we work on increasing the savings rate shows its power. Took us years to move to a savings rate of 10 %, invested surplus. Learned how to identify saving potential, focus on „quality spending and investing“. Savings rate rose to 30 % which means more money to invest. Then dividends really made a difference and now, for 2021 we can expect USD 15‘000, which lifts our savings rate further and puts more cash into our pockets… Read more »