The dictionary offers various definitions for Compounder, depending on the context. The definition that best fits our discussion here is: “To compute (interest) on the principal and accrued interest.” But beyond just definitions, the idea of compounding holds a significant place in both personal finance and investing strategies.

Here on the blog, I like to use two perspectives on the term Compounder: Compounder as a process and Compounder in companies. I believe that the best way to achieve meaningful returns over time is by understanding and applying these concepts—especially through investing in Compounder Companies.

The Compounder Process

The compounding process aligns closely with the definition provided earlier, but a more detailed explanation comes from Investopedia:

“Compounding is the process in which an asset’s earnings, from either capital gains or interest, are reinvested to generate additional earnings over time. This growth, calculated using exponential functions, occurs because the investment will generate earnings from both its initial principal and the accumulated earnings from preceding periods.”

The power of compounding lies in the exponential growth of your investment. It’s not just the initial investment that grows, but the reinvested earnings that begin to earn returns as well. This snowball effect is what can turn modest investments into significant wealth over time.

A Visual Example

Here’s an example of the compounding process in action. If you invest $500 a month, starting at age 25, and the investment compounds at an annual rate of 8%, by age 59, it could be worth more than $1.7 million.

Compounding Effect. Source

Compounding Effect. Source

To achieve this compounding effect, remember three key actions: SAVE, INVEST, REPEAT. Of course, it’s crucial to find investments that align with your desired returns, but that is a separate and complex topic.

Patience is the real secret to compounding. As Charlie Munger wisely says, “The big money is not in the buying or selling, but in the waiting.” Time is your best ally in letting the compounding effect work its magic.

Compounder Companies

With an understanding of the compounding process, let’s shift our focus to Compounder Companies. These are businesses that leverage the compounding effect internally, generating consistent returns over time.

A clear definition of Compounder Companies comes from Morgan Stanley:

“We define compounders as companies with high quality, franchise businesses, ideally with recurring revenues, built on dominant and durable intangible assets, which possess pricing power and low capital intensity.”

While this definition is thorough, I prefer a more streamlined version:
We define compounders as companies with a sustainable competitive advantage that can generate consistent, high returns over long periods.

Why Invest in Compounder Companies?

The ability of these companies to maintain and reinvest high returns makes them ideal for long-term investment. Their competitive advantage—be it through brand strength, intellectual property, or network effects—allows them to reinvest profits back into the business at attractive rates, leading to further growth. This reinvestment fuels the compounding effect, making them resilient and valuable over time.

A key distinction here is that we’re talking about investing in companies, not just stocks. Owning a stock means owning a part of a company and its potential for growth. Compounder Companies are particularly appealing because they can continuously enhance shareholder value through their ability to generate and reinvest profits effectively.

Happy investing, and may the power of compounding work in your favor!