How to find Compounding Machines (Chuck Akre)

Chuck Akre, who retired in 2020, is one of the best quality investors in the world. His insights can be useful for all quality investors. Chuck founded Akre Capital Management in 1989. Today, his firm has approximately $16 billion in assets under management (AUM). In this article, we will show you how you can invest in compounding machines.

Let’s start with a story. In 1626, Native Americans sold the island of Manhattan for an estimated $20 worth of beads and trinkets. Could you guess how much this $20 would be worth if these Native Americans invested this $20 at a rate of return of 9% per year and stuck with this investment program for the following 380 years? The correct answer is more than $3.335.000.000.000.000! It’s the same principle as when you would double a penny every day for a month, eventually this penny would be worth more than $10 million. This beautifully shows that you don’t need an extraordinary return to achieve extraordinary results. The only thing that is crucial, is having the ability to sustain an investment program uninterrupted over a very long period. Compounding can truly be beautiful.

Now let’s get back to Chuck Akre and compounding machines. Akre’s investment philosophy can be summarized as follows:

“We focus our capital in a select number of what we believe to be extraordinary businesses. These companies meet specific standards related to the business itself, the people who manage it, and the discipline they demonstrate when it comes to reinvesting free cash flow.”

Chuck refers to this investment approach as “The Three-Legged Stool”. As an investor you should buy great businesses with integer management which can reinvest a lot of their free cash flow in future growth. When you can find these companies, you discovered a (potential) compounding machine. These are the companies you are looking for as an investor.

First and foremost, you want to invest in great businesses. You want to invest in great companies with a strong competitive advantage. When a company has a high and predictable ROE and FCF, pricing power and a strong balance sheet, this is already an indication that you are looking at a great company.

When you have found a great business, you should look at the integrity of its management. Do they have skin in the game? Are the interests of you as a shareholder and management aligned? You want to invest in companies where management focuses on long-term value creation.

“Never ask anyone for their opinion, forecast, or recommendation. Just ask them what they have in their portfolio.” – Nassim Taleb

So, now you have found a great business with integer management. Finally, secular trends are very important for quality investors. You want to invest in companies that can reinvest a lot of their free cash flow to achieve future growth. These kind of companies can grow their free cash flow per share exponentially. Look at See’s Candies for example. Warren Buffett bought See’s Candies in 1972 for $25 million. Today, See’s Candies has generated more than $2 billion (!) for Berkshire Hathaway.

The ROIIC or Return on Incremental Invested Capital is a great metric to look at reinvestment opportunities. You can calculate the ROIIC by dividing the change in the net operating profit (NOPAT) in the current period by the change in invested capital in the previous period.

When you found a great business with an integer management and plenty of reinvestment opportunities, you have found a (potential) compounding machine. These companies are quite rare as only a few companies in the whole world meet all 3 criteria.

If you can buy compounding machines at a fair price, you will end up with great investment result.

“It’s far better to buy a wonderful company at a fair price than a fair company at a wonderful price.” – Warren Buffett

When we look at the results of Chuck Akre, we conclude that as of today the Akre Focus Fund managed to grow with 421% since 2009 compared to 275% for the S&P500. Chuck Akre’s fund grew at a CAGR of almost 15% since 2009. When you would have invested $1.000 at the launch of the fund your investment would be worth $5.214 today:

Mastercard, Moody’s, American Tower, Visa, and Constellation Software are the five biggest positions today of the Akre Focus Fund. American Tower has been in Chuck’s portfolio since the launch of the fund in 2009, meaning that Chuck made a tenbagger on this stock.

Chuck Akre is a great investor who we can learn a lot from. All positions of the Akre Focus Fund and some fundamental characteristics can be found here:

Do you want to learn more about Chuck Akre? His Google Investment Talk ‘Trying To Solve The investment Puzzle’ is very insightful:

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