Summer inspiration: the importance of compounding returns
- 16 September 2024 (5 min read)
A few lucky picks in a portfolio can boost returns in the short-term, but long-term investment success is based on compounding returns from companies that can deliver steady growth, year after year. As he enjoyed the summer sun, Nigel Yates, portfolio manager of the AXA Framlington UK Select Opportunities fund, contemplated the key characteristics of companies that have the potential to offer outstanding long-term returns.
Summer is my favourite season. What’s not to like about trips to the beach, barbeques with friends or warm evenings and cool drinks as the summer sun sets? But now, the kids are back at school and the tan is fading. Christmas decorations are nudging barbecues, Pimms and sunblock off the supermarket shelves. Summer is over.
Back at my desk, I’ve been reflecting on my summer reading. My choice this year was The Psychology of Money by Morgan Housel (Harriman House, 2020), a remarkably insightful book with timeless lessons on wealth, greed and happiness. In a book brimming with fascinating observations, I was particularly drawn to the chapter on “Confounding Compounding”.
Seeing past the glare of shooting stars
Compounding returns is a central tenet of our investment philosophy for the AXA Framlington UK Select Opportunities Fund, and Housel coherently and convincingly lays out why.
He reminds us that the key to investment success is not generating outstanding returns in any one year but rather producing good returns that can be repeated for the longest period of time. Housel points out that no one would have heard of Warren Buffet if he had started investing at 30 and retired at 60. It is the sheer longevity of his returns, compounded over time, that makes him stand out.
It’s this long-term mindset that we look for in the management teams of the companies we invest in. Above everything else, we look for a company with a capital allocation policy that prioritises organic investment over dividends and buybacks alongside the resolve to prioritise their future progress, even in more challenging economic environments.
Additionally, there needs to be a deeply embedded culture of innovation throughout the organisation, where internal ideas are encouraged and backed by management’s time and capital. It is important to have a number of new ideas incubating at the same time, ideally spread between optimisation, customer engagement and monetisation. It is also vital to have a balance between next iterations and step changing innovations.
Compounding returns from barbecues, beach trips and summer bugs
As I enjoyed the long summer days, with Housel’s clear exposition on compounding in mind, a number of companies in our portfolio jumped out at me as showing that long-term compounding mindset.
Enjoying a summer barbecue, I thought of Cranswick, which provides a range of high-quality fresh products including pork, gourmet products and poultry that would be perfect on the grill. Year after year they have focused on investing in the business through capacity expansion, technology enhancements, product innovation and customer service. They are always thinking ahead, laying the foundations that will enable the business to continue to prosper well into the future.
These two charts from their 2024 Annual Report demonstrate what a high-quality management team with a long-term mindset can deliver.
Summertime trips to the seaside conjure up images of those iconic Art Deco-style British Rail posters to exotic places such as Eastbourne or Bridlington. These days a trip to the beach can now be booked at the click of a button thanks to Trainline, another good example of a business focused on the long term, with a vision to be the world’s number one rail platform.
The simplicity of their offering and seamless user experience belies the complexity of the UK’s rail system. They continuously invest in their product to bring ever more personalised, user-friendly features to delight their customers. They have also been expanding geographically as rail markets liberalise, enabling their platform to be best placed to aggregate carriers and optimise consumer choice globally.
While markets can occasionally fret about government intervention in the rail market, Trainline continues to invest and take market share in a significant, addressable market opportunity. This long-term compounding mindset has meant they have increased their market share in the UK from around 10% in 2017 to 33% in 2024 2024 (source: Trainline/ Rail Delivery Group, August 2024). They have also set their sights on Italy and Spain, and while it’s still early days, they’ve shown rapid growth increasing their market share from a negligible amount to around 7% and 6%, respectively (source: Trainline).
In all this misty-eyed summertime nostalgia we shouldn’t forget that even in the greatest of seasons not everything goes according to plan all of the time, such as the nuisance of wasps at a picnic or being bitten by mosquitos as we try to enjoy warm evenings outdoors. Which brings us to the last of the companies in the portfolio with a summertime vibe to highlight: Rentokil.
It is a leading global company in pest control and hygiene & wellbeing services, with a long-term track record of revenue and EBITDA growth. This has been driven by strong structural growth thanks to increasing urbanisation and a rising middle class with an intolerance to pests. It has always benefited from its long-term compounding operating model driven by high levels of customer and staff retention, a strong safety track record and being a global leader in technology and innovation.
Despite all the long-term attractions of this business, Rentokil’s last trading statement delivered the proverbial wasp at the picnic as integration issues from their recent Terminix acquisition have caused its North American business to underperform. It is a reminder that even companies with long-term structural advantages such as Rentokil can occasionally misstep. This has not gone unnoticed by activist investors and – if the rumours are true – private equity could be buzzing around.
In a market that feels like it is (over) reacting to every single data point, it is important to remember that focusing on the long-term can be the best investment strategy, whatever the season.
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