Compounding

Albert_Einstein_Head

I’ve become interested in the stock market.  To be precise, I have become interested in the  travel and leisure industry businesses in the stock market.  I discovered a quote by non other than Albert Einstein who stated that

Compound Interest is the most powerful force in the universe

I started to think about long term investments, the potential returns and how ones goes about it, surely its all down to whoever is running the companies and the management teams?  so….

I also read The Outsiders by William N Thorndike Jr, it’s a magnificent book regards the study of 8 outstanding CEO’s from the 1970’s to 2010’s.  One CEO featured is Mr Warren Buffett who also talks about compound interest.  So, thats two well regarded (to say the least) people talking about the same subject.

 So, compound interest is adding the interest year after year.  So, £20,000 invested at 6% annual rate gives £21,200 in 12 months.  However, if you keep the 6% interest in the account and wait another year the £21,200 has turn to £22,472, after another year its£23,820,   After 10 years the amount would be £35,816.  Thats an extra £15,000 or so.

Yet, lets say the £20,000 was invested in a small portfolio of shares and the performance of those companies regularly outstripped the stock market, thus the value of the shares was rising by 20% per year.  After 10 years the £20,000 has turned into £123,834.  So its clear, investing in well performing businesses who maintain that performance over long periods is good.  A good explanation can be found here.

The risk is of course, the companies don’t do well and under perform, thus your £20,000 may be worth £20,000 in ten years time which is of course a substantial devaluation (or loss) as a result of inflationary pressures (i.e.:  money today is worth less in the future).  Hence the management is the single most important factor.  Of course there are market conditions but as Thorndike explains in The Outsiders, a CEO can only play the cards they’re dealt.  Performance can be measured against the market, peers and value per share.

So, I have been in the UK travel and leisure industry for 15 hers now, I know thats not nearly as long as some veterans and it’s probably only 30% of my career however, 15 years is still 15 years.  I like to think I know a little about whats going on, whats good/bad/average etc..anyway, I am thinking of taking a punt in some shares but only in the travel and leisure sector as thats what I know.  I’ve also decided this is a minimum 10 year project (no point doing less otherwise you lose the benefits of compound interest).

Having said that, I wish the fundamental values of the stock market / shareholders would move and place less emphasis on quarterly rising profits and more emphasis on long term growth, wealth distribution, R&D projects and sustainability initiatives.  Surely the current economic model must change but it can only change if expectations of shareholders change.  Progress reports to follow in the months coming….

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