Joys Of Compounding By Gautam Baid

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November 20, 2021

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Strategic Alpha

Key Learnings and Lessons from the Book ‘Joys of Compounding by Gautam Baid’

Gautam Baid grew up in India and then moved to the USA. He served at the Mumbai, London, and Hong Kong offices of Citigroup and Deutsche Bank as a senior analyst in their healthcare investment banking teams.  He then worked as a portfolio manager at an SEC-registered investment advisor based in Salt Lake City, Utah.  He is the Founding Creator at Chapter, a learning platform. Gautam Baid is the author of the international bestseller ‘The Joys of Compounding.’ The key learnings and lessons from this book are as follows:

Be a learning machine

‘Those who keep learning keep rising in life.’-Charlie Munger

It is important to inculcate the habit of reading to learn. Reading keeps the mind growing and gives information from various areas. It is a form of vicarious learning, where you can learn from the best minds and even dead people. Warren Buffett is known to spend a significant portion of his time reading.

Latticework of Mental Models

It is necessary to know the big ideas from different fields besides specializing in an area. The latticework of mental models gives these big ideas. It also helps make better and rational decisions in both investing and life.

Even great investors like Warren Buffett make mistakes. Warren Buffett’s letters to shareholders regularly discuss his investing mistakes. Mistakes are great teachers. Learning from common investing mistakes and the mistakes of great investors helps in avoiding these same mistakes. Also, when someone himself makes mistakes, it is necessary to admit them and learn from them.

Be passionate and focused

It is important to find out what a person’s passion is. After finding out this, it is important to do what a person is passionate about. Vocation lies in the areas where passion and worldly needs meet. The Japanese concept of igikai helps in finding out a person’s profession.

Also, it is important to be focused on the tasks rather than being distracted. On the idea of focus, Bruce Lee says, ‘I fear not the man who has practiced 10,000 kicks once, but I fear the man who has practiced one kick 10,000 times.’

Hang out with people better than you

It is important to find good role models. In the investing field, people can find legendary investors like Mohnish Pabrai, Warren Buffett, Peter Lynch, etc. as their role models.  If you don’t know things, then it is important to find a mentor who would know more than you. Mentors even work for people who are already successful.

Be humble

If some people become successful and rich, they might make some bet which is much higher than their risk appetite in order to win bigger. If the bet doesn’t work, such people may lose what they have. Also, the attitude of knowing everything makes people stop learning, leading to their downfall. So, stay humble and keep learning.

Achieving Financial Independence

It is important to achieve financial independence. Saving and investing is important to achieve financial independence. It is also important to live below your means. It is possible for any person to achieve financial independence. Charlie Munger, Warren Buffett’s partner, was not born rich, yet is very wealthy now. It has to be noted that financial independence does not mean you don’t work.

Delaying Gratification

Delaying gratification implies enjoying later rather than enjoying the present. Patience is one of the important virtues in investing. In investing, you need to wait with patience and when the opportunity arises, you need to scale up.

In addition, you need to be better at 1% every day. Here is a chart of becoming 1% better every day and 1% worse every day. The results are here to see:

 

Think like a business owner

When you buy a stock, you need to think like you own a business. Buying listed stocks offer a number of advantages. You can buy and sell stocks whenever you want. It requires a small amount to invest in stocks and become owners of businesses. It also gives access to great management teams if you buy stocks of good companies.

Importance of checklists

‘Checklist routines avoid a lot of errors. You should have all this elementary (worldly) wisdom and then you should go through a mental checklist in order to use it. There is no other procedure in the world that will work as well.’      Charlie Munger

Checklists are important to make decisions. They also help us in avoiding being over-confident about our own abilities. Investors need to ask the right questions in investing. The right questions will fetch good answers, which will help in decision-making.

Estimate Intrinsic Value

The intrinsic value of a stock is the sum of cash flows expected to be generated from the company over the useful life of the company, discounted at an appropriate rate of return. The discounting rate is determined by the time value of money and the uncertainty of receiving these cash flows. It is important to estimate the intrinsic value of the stock. Calculation of intrinsic value is an art because it is based upon estimation of the future, which is uncertain. While estimating the intrinsic value through Discounted Cash Flow (DCF) method, it is not necessary to be precise as investors are business analysts, not securities analysts.

Have a margin of safety

The next step after estimating the intrinsic value is to buy the stock if there is a margin of safety. The margin of safety is when you buy a stock when it is significantly below intrinsic value. If you pay an excessive price for even high-quality stocks, the future returns would be low. A case in point was Nifty 50 companies, a group of premier growth stocks that had a high institutional interest in the USA in the early 1970s. Here is a table of the 10-year returns of some Nifty 50 companies in the USA since June 1972.

Company PE Ratio 10 Year Returns
McDonald’s 85 1.75%
International Flavours and Fragrances 75 -5.24%
Walt Disney 81 -3.78%
Johnson and Johnson 61 1.72%
Coca Cola 47 -6.93%
Eli Lilly 46 -0.72%
Merck 46 -0.23%

Source: Lawrence Hamtil

Managing Portfolio of stocks

It is important not to over-diversify the portfolio. Many people argue that diversification reduces risk. But Joel Greenblatt has an interesting thing to say about diversification. He says, ‘Two things should be remembered, after purchasing six or eight stocks in different industries, the benefit of adding even more stocks to your portfolio in an effort to decrease risk is small, and overall market risk will not be eliminated merely by adding more stocks to your portfolio.’

Keep Things Simple

‘The simple ideas with the intensity of pursuit are what get you to the promised land.’ -Mohnish Pabrai

Many words of wisdom shared by great investors are ignored because they may be considered to be too simple. It is widely said that investing is simple, but not easy. Don’t make things complex. However, it has to be realized that simplicity is the result of long hard work.

Update your beliefs in the light of new evidence

There is a behavioral bias in investing known as confirmation bias. Confirmation bias implies we constantly seek information that validates our existing beliefs. However, investors need to avoid confirmation bias. They need to try to find information that contradicts their existing beliefs and then update these beliefs in the light of new evidence. In this context, economist John Meynard Keynes has quoted, ‘When the facts change, I change my mind. What do you do, sir?’

Power of Compounding inequities

Let’s take a small illustration of the difference investing in debt and equities makes in the long run. Let’s assume Rs 30,000 is invested today for 40 years. The rate of interest assumed in debt is 7% and returns in equities (inclusive of dividends) are assumed to be 17%. Rs 30,000 invested in debt will become Rs 4,50,000 in debt over 40 years, while inequities it will be Rs 1.60 crore. The significant difference is the power of compounding over extremely long periods.

The concept of compounding does not merely apply to wealth. It extends to other areas of life as well. If you give without any expectations, your goodwill compounds. Similarly, if you take care of your health, your other areas of life also improve. If you are a continuous learner, your knowledge compounds. 

 

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The author of the blog Mr.Suyog Dhavan is a Full-time Investor / Value Trader and Value investing/Trading Mentor. His style of Investing is inspired by Mohnish Pabrai, Peter Lynch, and Porinju Veliath. He is the founder of Strategic Alpha Wealth, A Premier stock market mentorship firm with a mission to touch the lives of 1Lakh people through its mentorship program.

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