Healthy Return + Good Growth = Compounder

While I’m still reading and listening to as many investing mental models as I can, the one thing that I’ve learned that has reshaped my thinking of great companies is their ability to have a healthy return with the ability to grow incrementally.

A healthy return likely means the ability to generate earnings with the capital it retains (i.e. retained earnings) beyond some kind of risk-free or hurdle rate.

Good growth means that that the business can grow their revenue (and/or earnings, free cash flow, cash from operations etc.) with little or a nominal amount of incremental capital. Meaning: can the company grow net new or organic business with not too much reinvested in it.

There’s many ways of thinking of what are the best investments with the use of what a moat is, looking a different accounting metrics and KPIs, but these two seem to be the most impactful that I’ve found so far.

This, of course, only speaks to the quality of the company not the valuation.

Here’s a couple variations of how this translates in the minds and words of my favourite business people and investors:

Connor Leonard’s formula:

Mark Leonard’s (no relation) and Constellation Software’s formula: