Book Summary (12/31) : The Joys of Compounding

Chapter 12 : Building Earning Power Through A Business Ownership Mind-Set

1.An investor builds earnings power through a business ownership mind-set. Investing in publicly listed businesses is a great way to passively reap most of the major benefits of running one’s own business, without being exposed to the disproportionate risks emanating from the usual vagaries of directly running a business.

Investing is most intelligent when it is most businesslike.—Benjamin Graham

2. The possibility of partly owning a business with a small investment corpus : For a person coming from the middle class, capital is usually a big limitation to starting a business. This is not to say that if a person has a great idea, he or she will not find the needed capital to fund it. Often, however, this is the most challenging part of starting a business.

Suppose someone wants to set up a small-scale chemical factory in the state of West Bengal, India. The minimum initial equity contribution required may be of the tune of approximately INR 10 million, or about US$140,000. This might mean investing one’s entire life savings in a single venture, which may or may not work out. Alternatively, that person could invest just a fraction of this amount and own part of Vinati Organics, the world’s largest manufacturer of isobutyl benzene (IBB) and 2-acrylamido 2-methylpropane sulfonic acid (ATBS). It would take years, if not decades, to replicate its global market leadership from scratch. If one looks at return on capital employed, Vinati generates returns in excess of 30 percent. Thus, even with a smaller ticket size, an investor could generate better returns on capital employed than could have been obtained, in most cases, from a privately owned chemical factory.

3. Minimizing risk through diversification : No matter how well you may know your stocks, every business has unknown risks. Few can know about a Satyam, an Enron, or a Ricoh India in advance. Diversification protects investors from the risk of ruin as a result of a natural calamity or any other significantly adverse development in one or two businesses.

Sometimes, factors like currency depreciation or rising interest rates hurt some of our portfolio companies while benefiting others, so that the overall impact is muted. Most notably, if we invest in a diversified portfolio of good businesses, then most of the time the tailwinds pushing a few businesses forward will compensate for the headwinds pushing back the others, thus protecting us from permanent loss of capital.

When you think like a business owner, you no longer view stocks as pieces of paper or buy them with “target prices” in mind. Instead, you view stocks as part ownership in a business and you want to savor the journey alongside the promoters.