A wonderful business can be either a “compounder” or a “cash cow”. The distinction matters greatly for what you should be willing to pay. Originally, Buffett described a compounder as a business that is able to earn a high return on invested capital, and than reinvest all those earnings back into the business to continue earning high returns.
This is true, however, in the digital age compounders are often capital light businesses. They can grow without massive reinvestment. Simultaneously, while this description helps to categorize businesses, it doesn’t help in recognizing them.
In Adam Seessel’s BMP framework, a step in the B (“business”) section does this. He describes high scoring businesses as those with small marketshare in a large and growing market. That is what a candidate business needs to meet the potential compounder criteria. When you pair it with a strong moat to protect it from competition, can you be confident that you have found a wonderful, digital compounder.
Connections
Investing Is A Qualitative, Not Quantitative, Game
Link Explanation: This is actually an area where investing does cross into the qualitative area. However, it is much more simple than a DCF and does not require nearly as much specific prediction. Instead, it simply requires assessing the current marketshare of the business, whether the business provides that to you or not, as well as how fast that market is growing overall.