‘Only as good as next day’s trade? That mindset risks putting short-term tactics above long-term strategy’

Many of our industry stakeholders understand the power of compounding, yet few actively employ it as a strategy to create value over the long term, especially not targeting 100 times your money in return.

The problem is largely down to impatience and a lack of tolerance for short term volatility. Industry commentators such as stock market analysts are actively disincentivised to focus on it as many hedge funds don’t do ‘long-term’ and short-term revenue is what counts.

A common mantra I hear from retail boards is that “you are only as good as your next day’s trade” which, while it has some resonance, risks a boardroom that thinks only about the tactical and not the strategic.

Most industry commentators believe that the retail and consumer sector is challenged, yet it makes up about 35% of the world’s companies and, with patience, very significant gains can be made.

Try googling the 10 richest people in Europe and see how many retailers and brand owners appear? A lot. What is now large, once started small. Starbucks began in 1971, in Seattle, as a small store selling coffee beans and is today worth $95bn (£70.2bn).

 In simple maths terms, if you have a company that delivers 20% annually for 25 years, you achieve 100 times your money

A cursory glance at the top 10 companies that delivered more than 100 times their money to investors over the last 50 years includes Walmart (which took just 12.5 years) and our long-time strategic partner TJX, which took 28.5 years but today has a market cap of $141bn and clear leadership still of its unique business model.

I write often about return on capital employed but, in simple maths terms, if you have a company that delivers 20% annually for 25 years, you achieve 100 times your money. But, illustrating the patience and compounding point, if you sell in year 20 you will only make 40 times your money – the power is in patience and reinvestment.

What is the key to delivering ‘100 baggers’? The first is return on equity (ROE). Over time, share price performance should mirror ROE and it is the ability to reinvest those profits in similar ROE business cases that delivers long-term compounding growth. Secondly, owner operators, skin in the game. Historically, according to Shulman and Noyes research, companies with sizeable insider ownership beat the index by 7% annually.

They are less obsessed with quarterly earnings, invest more in research and development than flashy acquisitions, and focus on building long-term shareholder value given their personal wealth at risk. Competitively, the management also boasts a tremendous track record of keeping competitors out over time. Lastly, as investors, don’t get bored and ignore forecasters.

Victorian Plumbing has delivered 67% ROCE average over the last seven years, resulting in more than100% return on equity

Illustrating this idea of short term versus long term and how stock markets get this wrong, there are numerous examples that we’ve looked at as part of our recently assembled True Public equities portfolio that meet the criteria outlined above, but one addition in particular recently stands out.

Reflecting on the above criteria, Victorian Plumbing has delivered 67% ROCE average over the last seven years, resulting in more than 100% return on equity on average. Additionally, the founder and his wider family are not only involved in the business but passionate about its every move, collectively owning approximately 60% of the company’s equity.

In the short term, the business has announced three notable things. First, it has invested heavily in a state-of-the-art warehouse to allow it to scale from here. Second, it has removed a key competitor by acquiring its IP for a de minimis sum and most recently by investing in R&D to relaunch formerly the largest UK furniture brand, MFI, sweating its existing infrastructure and ecommerce expertise.

The MFI investment, which dramatically increased its total addressable market from £1.5bn to about £21.5bn is touted to cost just £3m in start-up costs given the business can leverage its existing expertise.

Alongside these very significant strategic moves, the business announced strong high single digit revenue growth, EBITDA growth of 15%, free cash flow growth of 50% and an increase in the interim dividend of 35% year on year. All in a market that most generalists consider uninvestable at present.

The upshot? The shares have fallen by 33% in the second half of May, or in cash value terms lost £100m for a £3m one off P&L hit and a 14 times expansion of market universe for the next leg of growth.

For long-term shareholders, this presents a significant opportunity to invest. The short-term volatility of stock markets, the noted frustration from analysts that they weren’t told of this development ahead of time (why would you be?) and the lack of belief in the drivers that deliver very material returns over time are what drive the entrepreneurs we need away from the stock market.

We need the reverse. We need long-term thinking and we need investors and entrepreneurs/owners who think about the ‘100 bagger’.