How to Weather The Storm of Entrepreneurship Through Compounding

Since my father and mother passed away when I was in my late teens I’ve been pouring heart and soul into our 3rd generation Canadian family business.  Good business with good margins… back in the day.  However fast forward three decades and today we consistently see our margins erode as clients (large publicly traded insurance companies) look at ways to save on the bottom line which is understandable given the improvement of insurance technologie.

In these current market conditions a smart forward looking entrepreneur big or small should ask themselves the following. What can I do today that will improve my company or group of companies viability and or sustainability over the next 5, 10, 30 years?

It's might look like a daunting task but one that requires entrepreneurs to reflect on.

It's been proven time and time again, the earlier an entrepreneur start reinvesting profits and or income into alternative passive income channels the more viable & sustainable #richer the entrepreneur is going to become in the future due to the power of compounding returns.

This all hinges on the entrepreneur's will aka discipline to build a reinvestment plan and sticking to it, no excuses.

The proof is in the pudding is an expression that means the value, quality, or truth of something must be judged based on direct experience with it—or on its results. The expression is an alteration of an older saying that makes the meaning a bit clearer: the proof of the pudding is in the eating.        

Some of the brightest minds and most successful entrepreneurs to ever live understand the importance and mathematical concept of compounding.

Warren Buffett has said, “Compound interest is an investor’s best friend.” Albert Einstein once said, “Compound interest is the eighth wonder of the world.” If it’s coming from these fellas, we should be heeding their advice!

The ultimate secret sauce of compounding is to start as early as possible to get the most out of compounding and secondly its the discipline to put profits or income to work consistently every single dang month.

$10k invested for 20 years at 6% grows to $367,855

$10k invested for 40 years at 6% grows to $1,547,619

If you invest $10,000 per year for 20 years at a 6% return, the portfolio will grow to $367,855. That works out to $200,000 in total investments and gains of $167,855. However, if you invest $10,000 per year for 40 years at the 6% the portfolio would grow to $1,547,619, which equates to $400,000 in savings and total gains of $1,147,619. So, the difference of $200,000 in additional investments translates into a difference of a million dollars in your final portfolio by starting earlier.

Real Life Big Cheese #'s Case Study

Warren Buffett, the single greatest investor, started investing at the ripe old age of 12 and by age 25ish made his first million. Today his net worth is over $100 billion and is the top 5 wealthiest person in the world. Its true that the 20+-% long-term return (double the S&P 500) earned by his company, Berkshire Hathaway, had a bad impact on his compounding success and net worth today. However the real secret behind his success is that he started investing consistently at an early age, allowing for the magic of compounding to really take hold. #discpline

From the age of 25, when Buffett made his first million, by the time he turned 50 he had amassed a net worth of $375 million. At age 60 he was worth $35 billion, and today he’s now north of $100 billion. In fact, 99% of Buffett’s net worth was earned after his 50th birthday.

Real Life small canadian cheese curd #'s Case Study

In our case almost two decade ago we started looking at investing in land and developed our very own 75 000 sq ft industrial property and took 10 000 sq ft and rented out the rest to cover off our mortgage expense fast forward to 2024 and we had a good chunk of passive income trickling in from our rented space and we decided to diversify and dabble into growth dividend stocks.

We are proud to report that this diversification now has powerful compounding effects occurring underneath the hood. Which in my experience is rarely understood & rarely discussed.

Here's how & what it looks like:

There are several ways stocks can compound in value in a way that other asset classes cannot, such as GIC’s and real estate. The are a few simples reasons:

Reinvestment of Profits: Companies retain a portion of the profits they generate to reinvest in the business. S&P 500 companies on average pay out about half of their earnings in dividends. That leaves another 50% of earnings available…

The earnings that are not paid out are invested back into the business.

No other asset class provides this.

So why does this aspect make stocks a superior investment class you might ask?

Simply put, this single unique aspect creates two forces that can generate a large compounding effect and here's how...

ROCE: The average company in the S&P 500 earned a return on capital employed (ROCE) of 13% last year. If the business retains half the earnings (that it did not pay out as a dividend), this is where the magic can start to happen.

If the company can continue to re-invest those earnings back into the business at its current rate of return (13%), the stock's value will grow nicely. But something else makes this even more powerful...

Price to Book Value: On average, companies in the S&P 500 trade on 3x book value. So for every dollar of earnings the company retains, they create $3 of market value.

This is not the same as the frequently uttered mantra that the majority of the return on equities comes from reinvestment of dividends. Dividends which are reinvested, have to buy the stock at the market price (3x book value).

Whereas each $1 of retained earnings, gets reinvested at book value (not 3x book value). So the reinvestment of retained earnings can create a lot of growth in the value of your shares.

The value creation effect of this is quite powerful, if you can own stocks that achieve above average ROCE. Which, as a result, can manage to translate each $1 of retained earnings into a market value which is a much higher multiple of book value.

If this is the case, the last thing you want is that company to pay you a dividend. If that company is achieving a high rate of return on earnings. This is perhaps illustrated best by Buffett's Berkshire Hathaway, which hasn't paid a dividend in over 50 years.

In conclusion

The biggest erroder of business success for any entrepreneur is ignorance and having tunnel vision just riding the wave during the good times.  Not knowing, understanding, ignoring how to create value can be fatal for any business.  Remember this, the value a business creates equates to the leverage aka negotiation power a business has.  The best way to increase business sustainability is to negotiate to the upside and that goes hand and hand with the value that you created yesterday, last week, last year or a decade ago.

Let's do this

SsF