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The invisible power behind the world's best investments

by , 09 January 2014

Over the long sweep of your investing lifetime, strategies that only work extremely well in certain market situations are unlikely to play a dominant role. The big secret therefore is something you can use all the time, for your entire life, as an investor. And here it is: Some companies are much better than others at compounding capital. Much better. Read on to find out more…

If your goal as an investor is to compound your savings over time, wouldn't it be easier to simply figure out which companies will compound your capital at an acceptable rate, buy those firms (and only those firms) at reasonable prices, and then do something else with the rest of your time?

Here's a simple, but powerful example, Porter Stansberry in Daily Wealth explains…

Well-run insurance companies can produce what's called an "underwriting profit." They are literally paid money in advance to manage your capital. And they get to keep not only the investment profits, but profits from the premiums, too.

That's like paying the bank to keep and use your money. No other business can compound capital so consistently.

Insurance companies have other fantastic advantages, too. They're nearly immune from economic factors. They're scalable. This list could go on…

They're a focus because well-run insurance companies are legendary compounders of capital. Buy them at reasonable prices, and it's impossible not to do well.

It's not an accident that the greatest investor in history, Warren Buffett, has long focused on insurance stocks and other companies that are highly capital efficient. That is, companies that are natural wealth-compounders.

Starting with his 1972 investment in See's Candies, Buffett gradually over the years shifted the bulk of his wealth into a simple, long-term compounding strategy…

While Buffett didn't abandon all other forms of investing, his largest allocations since 1972 have all used this compounding strategy. That famously includes his 1988 purchase of Coca-Cola… when Buffett put roughly 25% of Berkshire's capital into a single stock! Buffett had figured out the one, real secret of finance… the one secret to "rule them all”.

How to use a compounding strategy

To use a long-term, compounding strategy effectively, you really only have to answer three questions..
  1. Is the company in question able to produce very high returns on its assets? In other words, is it a great business?
  2. Are these unusually high returns very likely to continue for decades, without requiring large and ongoing capital investments?
  3. Can the management of the company be trusted? Will bankruptcy never be even a remote possibility?
If the answer to these questions is "yes," then all you have to do is simply not pay too much when you buy the stock.

Most of the companies that fit these criteria are branded consumer-products companies.

The secret to their long-term earnings power is very simple: It's their brand and the relatively unchanging nature of their products. These companies' products are so well-known (and adored) by customers that these firms can constantly raise prices to keep pace with inflation.

They don't require massive investments of new capital. There's no new gold mine to find and build. There's no patent that's going to expire.

All these firms have to do is continue to deliver the same thing, year after year. And that means they can afford to return huge amounts of capital to shareholders.

And the best part? Anyone can use this approach.

There's no safer investment approach than this one, as your returns are being manufactured by great businesses.

It's this seemingly invisible power that allows them to return massive amounts of capital to shareholders, a factor that sets them apart and greatly reduces investor reliance on capital gains.

This is incredibly important over the long term.

So there you have it, the invisible power behind the world’s best investments.

The invisible power behind the world's best investments
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