Patient Wealth creation

This is a commonly used, but rarely defined word. I am going to argue in this post that the sole purpose of investing is wealth creation.

Let’s take a numerical example. Let’s say you have 100 Rs. You can invest it in an FD at around 9-10%. At the end of 5 years, you will have around 161 Rs. We can call this the baseline level of return .

Have you created wealth in the above case ? I would say yes, as you have been able to increase your buying power over the investing period, but not by much (15% at best on average).

However the above example has a catch – I spoke about an average return of 15-17%. The reality is that the stock market returns are lumpy and you can have a period of 2003-08 of 30%+ returns and then a period of 2% returns for the next 6 years (2008-2013). So in this case, one is talking of wealth creation with an added level of risk.

The aspect of time
I arbitrarily considered a time period of 5 years in my example. What is the correct period? 1 month, 1 year or 20 years?

Let’s put the above two point together – One needs to make a level of post tax, post inflation returns over the investment horizon (10 years +) such that you can meet your personal goals. Why else would you put your money at risk?

It is fine to put your money in the stock market to feel macho about yourself – but let’s not call that investing. Bungee jumping off a cliff is also done for thrills, but no one calls its investing !

If you agree that the purpose of investing is wealth creation over a long period of time, it is important not only to earn high returns, but to also do it consistently over a period of time. There is no point earning 30%+ returns for four years and then losing 50% in the 5^th(Which will translate into an 8% annual return)

Now If you shift your focus from high returns (to feel good or boast about it) to consistent returns (to create maximum wealth), the investing approach changes.

If you are looking for above average, but consistent returns for the long run what should one look for ? If you are looking at earning a 15-20% return over a 10-20 year period , I would suggest looking for companies which are earning this kind of return on capital now and have the capability to do so for a long period of time.

Let’s look at an example here – This is a current holding for me and not a stock tip. The name is Crisil.

You can read the analysis here.
Following is a table of price, and annual return/ CAGR for the last 10 years

As you can see, even if you purchased the company on 31^stDecember each year (blindly without worry about valuation), you would have done well.  This result boils down to the following reason

–   The company has a wide and deep moat in the ratings industry due to government mandated entry barriers (none can just start a ratings agency),  Buyer power (Companies have to pay to get their debt rated and the cost is usually a small percentage of the debt) and lack of substitutes (even banks insist on company ratings now based on RBI directive).
–   The deep and wide moat has enabled the company to maintain a high return on capital of 50%+ for the last 10 years. The company has been able to re-invest a small portion of its profits to fund its growth and has returned the excess capital to shareholders via dividends and buybacks.

The catch
There always a catch in investing – nothing is as easy as it looks. For starters, this approach requires a huge dose of patience.

The other catch is that this approach is very boring. You find a few companies like crisil and then spend maybe 1 hr each quarter and a few hours every year end reviewing the progress. If the company is still performing as it always has, you have no further work left. If you are a professional investor, what are you going to do with the rest of your time ??

Returns over entertainment
Although this ‘rip van winkle’ approach makes a lot of sense, I am unlikely to follow it fully. I enjoy the process of investing, looking for new ideas and doing all kinds of experiments. At the same time, a major portion of my portfolio is slowly moving towards such long term ‘wealth creation’ ideas.

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Stocks discussed in this post are for educational purpose only and not recommendations to buy or sell. Please contact a certified investment adviser for your investment decisions. Please read disclaimer towards the end of blog.