Actionable insights — How to Identify Great Compounders

1. Derive a company's sustainable growth rate from ROIC × reinvestment rate, not from a forecast

1. Take the return on invested capital — the profit generated per dollar of capital already in the business.
2. Take the reinvestment rate — the share of profits the business can actually put back to work inside itself.
3. Multiply them. That product is the rate at which the business can grow using only its own cash, with no assumption about the market or the multiple.
4. Compare that number with what analysts are forecasting. A forecast materially above ROIC × reinvestment requires either an acquisition programme or outside capital — find out which.
5. Screen on both terms at once: a high return that cannot be redeployed and a large redeployment at a poor return both fail.

• A high ROIC produced by a small, fully-exploited asset base — the reinvestment term is then near zero and the business is a cash cow, not a compounder.
• Acquisition-led compounders that break the formula's "organic" assumption: this post pitches Diploma and cites Constellation, both of which reinvest chiefly by buying companies.

2. Test pricing power by the customer's cost share, not by brand strength

1. For each product, estimate what fraction of the customer's total spend it represents.
2. Ask what happens to the customer if the product fails or is unavailable — the cost of getting it wrong.
3. The combination of a tiny cost share and a large failure cost is what allows above-inflation price rises to go unchallenged, year after year.
4. Verify by looking for a track record of annual price increases without volume loss, rather than by asking whether the brand is well known.
5. Apply the same test to every subsidiary in a roll-up — the group's pricing power is only as good as the individual products'.

• Procurement departments consolidating suppliers, which turns many trivial line items into one large, negotiable one.
• A cost share that grows over time as prices rise faster than the customer's other costs — the mechanism eventually attracts attention.

3. Screen serial acquirers on entry multiple and post-deal autonomy, not on deal count

1. Find the multiple of earnings the acquirer habitually pays. Anything in the high single digits against a group trading far higher is arbitrage on its own.
2. Check whether the sellers stay: a founder retained with real autonomy is the cheapest form of management the acquirer will ever buy.
3. Identify the value added after the deal, and require it to be specific — cross-selling, centralised purchasing, pricing — not "synergies".
4. Confirm the target pool is deep and fragmented enough that the programme can continue for decades rather than years.
5. Then check the arithmetic of insight 1 holds on the acquired capital, not just the legacy business.

• Entry multiples drifting up as the acquirer grows and needs bigger deals to move the needle — the single most common way a roll-up stops working.
• Autonomy quietly replaced by central management after the founders' earn-outs end.

4. Treat holding period as an input to the return, not a consequence of it

1. Before buying, state how long the compounding argument needs to run to produce the return you want.
2. Check that nothing in your own circumstances — cash needs, mandate, reporting cadence — would force a sale inside that window.
3. Judge the position on whether the business's own growth arithmetic still holds, not on the price path.
4. Record the intended holding period alongside the purchase, so a later exit has to argue against something written down.

• Patience used to defend a thesis that has actually broken — the discipline only works if there is a separate test for whether the business case still holds.
• A track record measured from an unusually favourable starting point; 34-year charts hide long flat stretches.