Understanding Compound Interest

Given Mario Inc.’s price history, the important question is – how much money could you potentially make in 10 years, if the stock price doesn’t increase in Year 10 compared to Year 1? It might sound counter intuitive. However, even in this case you can tap in the power of compound interest. 

How to Profit From Compound Interest

It should be obvious that if you bought 1 stock in Year 1 and held it for 10 Years, nothing would change. You had €100 worth of stock in Year 1, you still have €100 worth of stocks in Year 10. No brainer. 

Note – we’re assuming this particular company does NOT pay any dividends.

But let’s imagine that year after year, through the ups and downs,  you buy 1 stock of Mario Inc. or equivalently around €100 worth of stocks if the price drops lower than that. How much would your stocks be worth after 10 years?

In this table below, I’m monitoring the investments every year and checking the year-on-year market value.

Here’s when things get interesting. After 10 years of buying religiously every year, your stocks are worth €1400, while you invested a total of €1190. This is a growth of 18%! While the market has actually dropped 17% (so, -17%) and this company’s performance has been quite bad over the years, to be honest. 

Compound Interest at its Best

Coming back to our original question on compound interest, note that in Year 4, the company’s stock dropped to €20, a typical drop a company would experience in a crisis the size of 2008-2010; one of those economic downturns that can push investors flat on their faces. Here’s the crazy things, in the example above you only invested €100 in Year 4. What if you had been more passive-aggressive and invested €1000 euro? Obviously, doing so implies you have enough reasons to believe the company will survive the crisis. 

Well, if you had invested €1000 in Year 4, when the stock dropped to €20 losing 83% of its value, this is what would have happened to your returns in Year 10.

The worth of your stocks in Year 10 is €5900, compared to the total you invested of €2090. That is a growth of 183%!!!

By the way, in this example, there’s also an interesting selling opportunity in Year 8 when the prices inflated to €250. In which case you’d have hit a return of 662%. These are insane numbers.

Learning Points on Compound Interest

To tap in the power of compound interest, it is important to:

• buy and hold for the long-term as time is an essential factor in the power of compounding;
• stay cool and be prepared for rough years, because these are the moments you can massively increase the future earnings;
• make sure you do your due diligence on the companies you’re interested in and are always cautious about the investments you make. Your choices should be based on the intrinsic value of the company and not on the speculations around it. Check my article on Owner Earnings Formula Part 1/2 and Owner Earnings Formula Part 2/2 to know more about this.