“Compounding is the 8th wonder of the world.”
– Albert Einstein
At LCM, we believe the best way to create wealth is to compound capital, and the best way to achieve this is by investing in stocks (companies) with durable competitive advantages. We call these businesses “great” companies.
Unless a company is in liquidation, investors are buying into the future earnings of the business, and the biggest threat to those earnings is competition. Great companies are dominating businesses that have high barriers to entry. Their protective barriers may be due to their brand, service, distribution, or peculiarities of the business. By being resistant to competition, we believe these types of businesses can be “compounding machines” for our client’s capital.
Capitalism is absolutely brutal. According to research by Hendrik Bessembinder, professor at Arizona State University’s W.P. Carey School of Business, since 1926 the best-performing four percent of listed companies accounted for all of the U.S. stock market’s gains during that time. Just 83 companies (0.32% of total) accounted for half and five companies (0.02% of total) accounted for 11.9% of net shareholder wealth improvement during this 94-year study period. JP Morgan Asset Management published the distribution of returns for the Russell 3000 (3000 stocks) from 1980 to 2014: 40% of all Russell 3000 stock components lost at least 70% of their value and never recovered. In short, all of the index’s returns came from just 7% of components.
These studies completely validate LCM’s strategy of focusing on only the very best businesses—dominating enterprises with durable competitive advantages. Currently, we monitor a group of over 60 businesses with these characteristics. This represents less than 1% of the total number of tradable stocks in the U.S. Capitalism is brutal. Shareholder returns are not evenly distributed; profits congregate to just a few companies. It is a fat tail event. Most companies will not make it, and the winners take all.
Having a durable competitive advantage is so important that, every year, Warren Buffett tells the CEO’s of Berkshire Hathaway’s over 100 privately-owned businesses just one thing: “Expand the moat.”
Professor Michael Porter, the Bishop William Lawrence University Professor at Harvard University, also said, “Competitive advantage is at the heart of a firm’s performance…and today the importance of competitive advantage could hardly be greater.”
To create true wealth, we need to capture the long-term benefits of compounding. At LCM, we research and invest in great companies by constructing portfolios within our clients’ brokerage accounts. We are long-term investors, and we do not let short-term market fluctuation affect us.
To reduce risk, we diversify our clients’ portfolios among approximately 15 – 25 companies, but are able to customize the number of securities or the amount of cash according to our clients’ risk tolerance. We monitor and adjust the portfolios as necessary and are continuously looking to add other great businesses to our clients’ portfolios to help them compound their wealth.
We want our clients to be confident that their capital will be invested in a safe and conservative strategy designed to capture the long-term compounding benefits from the earnings of great companies.
Disclaimer: Past performance is not a guarantee of future results. All investing involves risks. The potential for profit also includes possible loss of principal. There is no guarantee that the investment objectives shown will be met. Actual clients’ results may differ materially than the results portrayed. Please read our disclaimer and methodology under the research and performance section for a more detailed description.