Owner's manual

Dear partner,

On the 1st of October, the Compounding Quality Portfolio will launch.

The goal of this portfolio is to outperform the S&P500 with more than 3% per year in the long term.

In today’s article you can find an Owner’s Manual which tells you exactly what to expect.

We are partners

Please note that I called you a partner in the first sentence of this email.

From now on, I’ll always call you a partner.

Why? Because we’re in this together. My money will be invested in the portfolio with 100% transparency.

This means I eat my own cooking. If you do well, I do well and the other way around.

“My wife, Susie, and I have more than 99% of our net worth in Berkshire Hathaway.” – Warren Buffett

“We have an attitude of partnership. Charlie Munger and I think of our shareholders as owner-operators.” – Warren Buffett

“I think I've been in the top 5% of my age cohort all my life in understanding the power of incentives, and all my life I've underestimated it.” - Charlie Munger

Why is an Owner’s Manual important?

An owner’s manual is essential to make sure that you start this journey with proper expectations.

Compounding Quality is not for you if you want to:

❌ Get rich quick
❌ Blindly follow someone’s else’s advice
❌ Outperform the market every single year

You are in the right place if you want to:

✅ Learn and become a better investor
✅ Be assisted alongside your investment journey
✅ Outperform the market in the long term

For the portfolio, the rule of 3 from François Rochon will be used:

• One year out of three, the stock market will go down at least 10%

• One stock out of three that we buy will be a disappointment

• One year out of three, we will underperform the index

Aren’t you comfortable with the above? In that case this partnership might not be the right place for you.

Compounding Quality is looking for serious investors with a long-term mindset which want to compound their wealth in the long term.

“If you are a long-term investor, you should own high-quality stocks and close your ears to those who say a rate rise will cause you problems. If you are not a long-term investor, I wonder what you are doing in the stock market at all, and so will you one day.” – Terry Smith

The essence of the portfolio

The essence of the portfolio is very simple:

1. Buy wonderful companies

2. Led by outstanding managers

3. At fair valuation levels

We want to invest in the best companies in the world.

The portfolio will consist of 3 buckets, as you can see here:

• Owner-operator stocks:

  • Owner-operator stocks are companies that are still run by their founder

  • Academic studies found that family companies and founder-led companies outperform the S&P500 with 3.7% per year and 3.9% per year respectively

“Some of our key managers are independently wealthy. They work because they love what they do and relish the thrill of outstanding performance. They unfailingly think like owners. It are the best kind of managers we can wish for.” - Warren Buffett

• Monopolies and oligopolies

  • Only one or a few companies dominate the entire industry

  • Monopolies and oligopolies are usually great investments because they are able to operate at attractive conditions due to the lack of competition

“Over the years, Buffett followed his philosophy of buying into industries with little competition. If he can’t buy a monopoly, he’ll buy a duopoly. And if he can’t buy a duopoly, he’ll settle for an oligopoly.” - The Myth of Capitalism (Book)

• Cannibal stocks

  • Quality stocks which heavily buy back their own shares

  • When outstanding shares decrease, your stake in the company increases

“Pay close attention to the cannibals.” - Charlie Munger

Portfolio characteristics

✅ The portfolio will invest worldwide (developed countries only)
✅ We’ll own 15-20 stocks
✅ The portfolio is aiming to invest in the best companies in the world
✅ We won’t trade a lot. Activity and costs harm our results
✅ We won’t try to time the market (I’m way too dumb for that)
✅ The characteristics of companies in the portfolio:

• Sustainable competitive advantage

• Integer management with skin in the game

• Healthy balance sheet

• Low capital intensity

• Good capital allocation

• High profitability

• Plenty of reinvestment opportunities

• Trading at fair valuation levels

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

Portfolio goal

Let’s be honest with each other. We won’t outperform the market every single year.

There are only 2 kinds of people who can do this:

1. Cheaters

2. Liars

That’s why we’ll focus solely on the long term.

While Wall Street likes to think in quarters, we like to think in quarter decades.

Here’s what Jeff Bezos has to say about this topic:

The goal of the portfolio?

Outperform the S&P500 with more than 3% in the long term (> 5 years).

It’s important to highlight that Compounding Quality will never aim for the highest return. We aim for consistency and doing above average for very long periods of time.

Investing is a marathon, not a sprint.

Track record

In recent days, people have rightly asked questions about the track record of Compounding Quality.

I love questions like this as it shows that people are doing their homework.

The Fund I co-managed together with a colleague

It’s hard to prove the track record of a Fund when you want to stay anonymous, isn’t it?

For this one you need to take my word: the Fund I managed outperformed its peers with 3% per year on average.

My own portfolio

Since I started working for my last employer, I tracked my personal portfolio in Bloomberg.

Results since the beginning of 2020:

• CAGR Portfolio: +18.7%

• CAGR S&P500: +11.8%

Investable universe Compounding Quality

Compounding Quality’s investable universe consists of 150 stocks which are considered as ‘high quality’.

When you create an equal weighted portfolio with these 150 companies, you get the following results since 2011:

• CAGR investable universe: +21.0% (+1100%)

• CAGR S&P 500 +9.6% (+214%)

Always be cautious with backtests. You can prove with data what you want as long as you play around with them long enough.

Do I think that the investable universe will be able to outperform the index with 12% in the future? Absolutely NOT.

However, it shows you that the strategy has worked in the past.

The track record shown above is why I’m comfortable to state that we should be able outperform the index with 3% per year in the long term.

Questions

Do you still have questions?

Feel free to reach out to Compounding Quality here:

About the author

Compounding Quality has a true passion for investing and helping other investors. He aims to invest in the best companies in the world as it’s far better to buy a wonderful company at a fair price than a fair company at a wonderful price.

Compounding Quality used to work as a Professional Investor but left his job to help investors like you. The main reason for this? He was sick of the short-term mindset of Wall Street and wanted to genuinely do the right thing.

All readers of Compounding Quality are treated as PARTNERS. We ride our investment journeys together.

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