Compounding

Deeper Explanation

Compounding is often described as the eighth wonder of the world, and the arithmetic deserves to be understood, not just appreciated. A business earning 20% return on equity every year doubles its book value approximately every 3.6 years. Over 20 years, $1 of retained earnings grows to $38. Over 30 years, it grows to $237. The acceleration in the later years — the "hockey stick" of compounding — is what makes time the most powerful variable in growth investing. The implications for investment strategy are profound. The single most important decision in growth investing is not which stock to buy, but how long to hold it. A business that compounds at 20% for 20 years generates 37x the initial investment. Selling it after 10 years generates 6x — a fraction of the eventual payoff. The investor who exits a great compounder early because it "seems expensive" or because a short-term opportunity looks more attractive is destroying the most powerful force in investing. Nick Sleep and his partner Qais Zakaria designed the Nomad Investment Partnership around this insight. They concentrated the portfolio in a small number of businesses they believed could compound at high rates for very long periods — and then held them with minimal turnover. Their letters repeatedly return to the same theme: the mathematical advantage of long-term ownership of high-quality businesses is so large that it should dominate investment strategy. Compounding also operates in reverse. Permanent capital losses compound as permanently foregone future returns. A 50% loss requires a 100% gain just to break even — and each year spent recovering rather than compounding is a year of forgone growth. This asymmetry is the underlying logic of Benjamin Graham's "first rule: don't lose money." Not losing is not the opposite of compounding — it is a prerequisite for it.