Compounding is the process of building wealth steadily over time, as money creates more money and this process is regarded as one of the most important investing principles.
Companies that can compound wealth year after year have been dubbed ‘compounders’ by investing gurus such as Warren Buffett and they can generate huge returns for investors over time. Warren Buffett’s Berkshire Hathaway is considered to be the world’s best compounder, having grown book value per share at a mid-teens percentage rate every year since inception.
But Berkshire isn’t the only company in the world that has been able to produce an enormous amount of wealth for investors by compounding.
A mission for returns
Motor dealer Cambria Automobiles (LSE: CAMB) is on a mission to generate returns for investors. Since 2011 the company has compounded book value at a rate of 16.7% per annum as its low investment, high return model has allowed management to pay down debt and reinvest cash generated from operations into expansion.
Today the company reported interim results for the six months ended 28 February, which show a continuation of its historical performance. Rolling 12 month return on equity remains high at 22% and at the end of the period the company had net cash of £3.3m. A strong balance sheet has given management confidence to hike Cambria’s interim dividend by 25%.
However, despite these impressive performance figures, shares in Cambria trade at a discount valuation. At the time of writing, Cambria trades at a forward P/E of 8.3 and an EV/EBITDA ratio of 4.9, which is around half of the industry average. This valuation seems unwarranted because Cambria is one of the most productive public companies trading in the UK today. Only 10% of all the public companies in Britain currently produce a return on equity of more than 22%.
All in all, Cambria is one of the most profitable businesses in this country, and it also seems one of the most undervalued.
Like Cambria, Staffline (LSE: STAF) has also been able to compound shareholder equity at a steady, attractive rate over the past five years, thanks to a market-leading return on equity.
Since 2011, Staffline’s book value per share has grown at 14.5% per annum and last year the group achieved a return on equity of 19.1%. Nonetheless, despite these impressive metrics, shares in Staffline are trading at a discount valuation, a forward P/E of 10.1.
It seems investors are worried about Staffline’s reliance on European workers and how the company will deal with this exposure during and after Brexit. Analysts appear concerned as well as, after the firm growing earnings per share by 200% during the past five years, the City is predicting earnings growth of only 1% for this year followed by 5% for 2018.
Still, even if these forecasts prove true and growth slows to a crawl, Staffline shouldn’t lose its ability to be able to compound shareholder wealth as return on equity will remain elevated.
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Rupert Hargreaves owns shares of Cambria Automobiles. The Motley Fool UK owns shares of Cambria Automobiles. Views expressed on the companies mentioned in this article are those of the writer and therefore may differ from the official recommendations we make in our subscription services such as Share Advisor, Hidden Winners and Pro. Here at The Motley Fool we believe that considering a diverse range of insights makes us better investors.