The Star Principle & the Coffee Can Portfolio -looking at the same picture from different angles

Financial Independence, Uncategorized

I was re-reading the book – The Start Principle: How it can make you rich by Richard Koch.  If you have been following my posts you will know that I am quite a fan of his writings and have almost all the books that he has written.  Each time I re-read them, I identify something which I had not noticed earlier.

For all those of you who haven’t heard of Richard Koch, he was the first one to write a book on the 80/20 principle, also known as the Pareto principle.  He has written a lot of books related to the application of the 80/20 rule but in addition to that his basic slant has always been on strategy and has a lot of wonderful books written with strategy as the back drop.

If you want to read an author who simplifies strategy, not only for corporates but in real life, then he is one author you should read.

This time while I was reading the Star Principle once again, one aspect which leaped out of the book was that the Star Principle is so very similar to the Coffee Can portfolio which is covered by Saurabh Maukherjea in his book – Coffee Can Investing.

As per Richard if you invest in a company which is a leader in the market place and the market itself is growing at more than 10% compounded, then you will make money hand-over-fist if you can see that the market itself has longevity.  His logic is- if you invest in such a company in its early stages, then the possibility of making massive returns is even higher.  These companies are very few and far between and hence are STARS.

The concept of Stars, Cash Cows, Dogs and Question Marks was first propagated by the consulting company BCG (Boston Consulting Group) where Richard had his first job.

The concept of the Coffee Can portfolio was first espoused by Robert Kirby in 1984.   It was serendipity because Kirby had recommended a certain portfolio to a friend’s husband who did not sell any shares in the portfolio over a period of 10 years while Kirby did.  The amount of wealth that the portfolio created was way higher than what Kirby created in his portfolio.  This is the central concept of compounding which I keep harping about in each of my posts.  If you let something compound over long periods the amount created is enormous.

Saurabh takes the concept further and shows us examples with research, done over multiple blocks of 10 year periods, on companies which grew every year at a minimum of 15%.  If you had bought shares in those companies and then forgotten all about them for the next 10 years you would have got a very large return on your investment.  The number of such companies would be quite small.  If you extend the research to 15 year periods then the number of companies which had such consistent growth would be even smaller, but the certainty of returns would be much higher.

At the end of the day if there are only a few companies which can grow consistently year on year over such long periods of time then thats only possible if they are market leaders in the niche they occupy.  They also cannot continue to keep growing over long periods of time at such high rates, if the market itself is not growing fast enough.  Which then end up being STARS by the definition given by Richard.

The one difference which I perceive is that the Coffee Can portfolio does take into account the fact that some of the companies may close down  or lose market leadership by emphasising that you need to have a “portfolio of companies” with these characteristics.

So its not only about compounding but about creating a sensibly constructed portfolio of STARS which can create enormous wealth.

Wealth generation is not complex if you follow some simple rules….its not easy either though.

Till next time.

Carpe Diem

Compounding & successful organisations

Financial Independence, Uncategorized

Recently Tim Ferris had a podcast with Jill Collins.  If you have not heard of Jim Collins, he is the author of a lot of books which study how businesses succeed and fail.  One of his most famous books is Good to Great.  If you have not read it then its a must read for anyone who is even remotely interested in the corporate world.

If you haven’t heard of Tim Ferris or read any of his books the I highly recommend that you read his book The four hour work week and others.  The advantage of the podcasts is that you get to hear real life people and Tim goes into the interviews with a very detailed structure so that you can get maximum benefit

Coming back to the podcast with Jim Collins(if interested you can listen to the podcast  here). It’s a fabulous talk spread over about 2 hours but covers a very wide range of topics from “writing’ to Peter Drucker and to the Flywheel concept.  Jim had first introduced this concept in the book Good to Great.  But there it was more a chapter on how successful companies built systems to ensure each step helped them grow to the next and kept feeding.

However this flywheel concept was not elaborated further for a long time.  In the podcast Jim spoke about how he’s done more research on the Flywheel concept and written a monograph.  For me a monograph was a new concept. It’s a detailed study of a given topic. It’s less than a book but more than a whitepaper.

Since I was very interested in the flywheel concept from the time I had read the book, I immediately bought to read.  The big concept which stands out int he flywheel is the positive feedback loop.

Most of you would know of the negative feedback loop.  It helps control a process near a defined setpoint.  For example if you put car in cruise control, then if due to a gradient the speed starts going up then automatically the pressure on the acceleration pedal is reduced.  Another example of a negative feedback in your everyday life is the temperature control in the water heaters.  If the temperature reaches the set-point then the heating is stopped.  Negative feedback loops ensure control.

Positive feedback on the other hand is compounding at its core.  One good thing leads to another and another.  So Jim Collins gives multiple examples of companies like Amazon, Intel, Vanguard have used positive feedback to grow exponentially over a consistent period of time.

Which brings me to another book which looks at this same concept from a different angle.  Its a book by Perry Marshall called 80/20 Sales and Marketing.  Perry was influenced by Richard Koch who wrote the famous book on 80/20 many many years back.  Perry has taken the concept of 80/20 and explained the fractal nature of this law.  If you are in anyway related to sales or marketing you will find enormous nuggets for helping you in your sales or marketing career.

When I read “Turning the Flywheel” it reminded me of a similar concept in nature which Perry shows on how the Grand Canyon was formed and how the same positive feedback loops can be used to dominate Google Adwords.

More and more as I come across successes I am convinced of the fact that positive feedback (or compounding) changes everything in nature, businesses and financial life of people.

Would love to hear from you’ll if you’ll have seen any place else the impact of positive feedbacks.

Till next time.

Carpe Diem!!!

grand canyon during sunset

Photo by David Ilécio on Pexels.com

Interest rate differences over the time period

Financial Independence, Uncategorized

Last time I showed a graph and calculations of how a doubling of a bet for every cricket wicket or golf hole can make you a millionaire many times over if you allowed to take the bet over a large number of wickets.

The bigger part however is that the real advantage comes as you take the period over a longer term.

This time I will show you how the value of the bet can change the value of your earnings.  As I have repeated many times in my blogs earlier also, the value of money you end up with is has low co-relation to the amount you start with but rather with the duration and the rate of interest.

So this time also we will start with only one dollar to start with and show you how the value of the amount you get depends at the rate at which you grow your bet.  We will consider 8%, 15%, 17% and 24%.  There is a reason for choosing these rates.

Typically a long term bank deposit in India can get you about 8%.  Its almost guaranteed to not fail. So you don’t have to take any risk to get this kind of return.

15% -17% is the average return that the Indian stock market has returned on average.  24% is the kind of lowest return the investing gurus  have been able to generate from the stock market.

Wicket in cricket / hole in golf Rate of interest 8% Rate of interest 15% Rate of interest 17% Rate of interest 24%
1 1.08 1.15 1.17 1.24
2 1.1664 1.3225 1.3689 1.5376
3 1.259712 1.520875 1.601613 1.906624
4 1.36048896 1.74900625 1.87388721 2.36421376
5 1.469328077 2.011357188 2.192448036 2.931625062
6 1.586874323 2.313060766 2.565164202 3.635215077
7 1.713824269 2.66001988 3.001242116 4.507666696
8 1.85093021 3.059022863 3.511453276 5.589506703
9 1.999004627 3.517876292 4.108400333 6.930988312
10 2.158924997 4.045557736 4.806828389 8.594425506
11 2.331638997 4.652391396 5.623989215 10.65708763
12 2.518170117 5.350250105 6.580067382 13.21478866
13 2.719623726 6.152787621 7.698678837 16.38633794
14 2.937193624 7.075705764 9.007454239 20.31905904
15 3.172169114 8.137061629 10.53872146 25.19563321
16 3.425942643 9.357620874 12.33030411 31.24258518
17 3.700018055 10.761264 14.42645581 38.74080563
18 3.996019499 12.37545361 16.87895329 48.03859898
19 4.315701059 14.23177165 19.74837535 59.56786273
20 4.660957144 16.36653739 23.10559916 73.86414979
21 5.033833715 18.821518 27.03355102 91.59154574
22 5.436540413 21.6447457 31.6292547 113.5735167
23 5.871463646 24.89145756 37.00622799 140.8311607
24 6.341180737 28.62517619 43.29728675 174.6306393
25 6.848475196 32.91895262 50.6578255 216.5419927
26 7.396353212 37.85679551 59.26965584 268.512071
27 7.988061469 43.53531484 69.34549733 332.954968
28 8.627106386 50.06561207 81.13423187 412.8641603
29 9.317274897 57.57545388 94.92705129 511.9515588
30 10.06265689 66.21177196 111.06465 634.8199329

If you see the difference between the 8% and 24% rate of interest is 3 times.  However the outcome is 63 times different over 30 units.  If you were to look at an even larger period like say 50 units the difference will come out to be 1000 times.

The human brain is not able to comprehend this major magic of compounding when trying to compute mentally.

Now look at the columns which are with showing you 15% and 17% interest rates.  While the difference is only 2% if you see the outcome after 30 holes at 17% you have earned double then at 15%.  If you were to extend this to 50 holes then the amount at 15% would be 1083 while at 17% it would be 2566. A difference of 2.5 times.  Why am I showing you this.  If you pay 2% commission to someone to manage your investment then you lose that kind of money. 

The people like Warren Buffet or Raamdeo Aggarwal or Mohnish Pabrai have become so exorbitantly rich because they manage their own money and manage it a higher rate of interest for a longer period of time.

However even if you think you cannot manage on your own, its better to get some reputed ETF so that the cost of managing is very low.  Only in cases of some high growth markets look for managers to manage specialised funds.

Another thing you will notice from the table – till about the 4th unit all the values were not very far apart. But see how the 24% chart suddenly breaks into another orbit after the 10th unit and the gap widens so dramatically.

The biggest lesson in this post and the earlier one is however that you need to start at the earliest, with whatever you have and let it compound over a long period of time.

For those of you who are more visually inclined, you can have a look at the chart below

Screenshot 2019-03-24 at 10.53.09 PM

Till next time choose the right interest and keep it for a long long time

Carpe Diem!!!

Compounding & the relevance of period

Financial Independence, Uncategorized

Last time I had written about why human beings are attracted always towards the complex items and don’t understand simple concepts like compounding.

One thing which comes to my mind is the fact that compounding works on 2 key parameters….longer periods of activity(of years in case of money)  and higher rates (of interest in case money).  While the human brain is very good at figuring out things quickly by identifying patterns, it gets completely foxed when complex calculations need to be done.

For the first 4-5 periods of activity, there is no appreciable change if you when you start with small values, because of which it seems that nothing worthwhile is happening.  So if you have started with 1 Rupee after 5 years if you only have got 2 rupees you are not able to comprehend how big the number can become. Its only later that the fun starts taking place.

Look at the table below.  The IPL cricket season is about to start in India and people in India could relate to this idea. It could be wickets in a game of cricket or holes in a game of golf.  We will start with a dollar for every wicket / hole taken in a match and double it for the next one till we take 18 holes in golf or wickets:

Wicket in cricket / hole in golf Amount doubled after every wicket/hole
1 1
2 2
3 4
4 8
5 16
6 32
7 64
8 128
9 256
10 512
11 1024
12 2048
13 4096
14 8192
15 16384
16 32768
17 65536
18 131072

Would you wager a bet with anyone on doubling the amount on each outcome.  You wouldn’t if you see how what starts with just a dollar becomes more than One hundred Thirty thousand dollars.  As a matter of fact Tony Robbins has a post specifically on this idea.

If you were to take this forward to a 22nd wicket/hole can you comprehend the value – it will be …it will be 2 million (20lakhs)….and by the 30th hole it would have become…Half a billion dollars (or 500 crores).

Warren Buffets actual growth of wealth has been after the age of 60 because of this phenomenon.  Its the age of the investments that have enabled the compounding to start playing a role.

Think about it.  If you were to ensure that you were to keep money for your child from the time she is born, you will make her a real rich person by the time she is 45-50 without her doing anything….at all.

For those of you who are more visually inclined pls have a look at the chart below

Screenshot 2019-03-17 at 10.22.33 PM

Next time we will take the same example by comprehending different interest rates and show how the different rates can change the graph.

Till next time.

Carpe Diem!!!