I like to invest for the long term. When I buy a stock, I am mentally prepared not to sell that business for 10 years or more. Why is this? Because true long-term wealth comes from buying businesses that can compound their earnings at high returns on invested capital over a long time period. I want to make sure that I give the businesses I buy the runway to be able to grow and compound their earnings over long periods so I can make multiples on my invested capital.
However, it’s a very special business that you can confidently say that you’ll hold for 10 years. And it’s a truly exceptional business that you can say that you’ll never sell. I don’t find it an easy process to accumulate a portfolio of such exceptional business. Part of the approach that I use to try and identify these businesses to accumulate is to find those that are riding long-term secular tailwinds.
Some of the secular trends I follow include the shift from physical in-store commerce to online commerce, offline advertising (newspaper, TV, radio) to online advertising, the trend from cash and check based payments to digital payments and the move from on-premise enterprise software to the cloud. However, even successfully identifying these trends doesn’t guarantee long-term success.
The businesses that benefit from these trends also need to be competitively advantaged in the sense that they are able to capture a significant amount of the value that they create. There’s no point in buying a business in a fast-growing industry if it gives up all of its value creation to its customers. That's not going to ensure solid investor returns. The business needs to have such significant advantages that can last such a long duration that it can not only lock out existing entrants, but potentially even the new upstart businesses that will inevitably come along that may also have a better product.
I've attempted to apply exactly this framework and lens in compiling my high-growth portfolio, Project $1M, which consists of investment in high-growth businesses and has the objective to grow an initial starting capital base into $1 million over 10 years. My theory was that such businesses could not only grow strongly and capture value, but also stand the test of time. So far, the portfolio has returned over 20% per annum annualized over nearly 4 years and has significantly outperformed the S&P 500. However, while it is structured as a long-term buy and hold portfolio, there are some businesses in the portfolio that I could confidently say that I would hold forever. These are the five businesses that make that cut.Mastercard
When it came to constructing my Project $1M portfolio, I thought of the businesses in the portfolio as players on a football team, each with different roles, but ultimately responsible for powering long-term earnings growth and value creation. When it came to selecting the quarterback, the go-to player that I could rely on to deliver me consistent returns, I looked no further than Mastercard (MA), which was my first pick to go into the portfolio. The reasons for this are plentiful. The company is riding the multi-decade long tailwind in the shift from cash to digital payments. We are still in the early innings of this, even though it seems like digital-based payment has been around forever. Mastercard estimates that digital payments only account 10% of its total addressable market, which includes personal consumption expenditure and real-time business payments. Additionally, it also benefits from other meaningful trends in the deployment of mobile point of sale (MPOS) that the likes of Square (SQ) and PayPal (PYPL) are aggressively pursuing, as well as the secular shift from physical retail to e-commerce, which can't be cash-settled.
When it comes to having competitive advantages, there’s probably no better example of the business that has these than Mastercard. Credit card networks have huge moats. It's not an easy task to set up a network, with banks needing to issue the cards, consumers to use the cards, and merchants to accept the cards. The network effects are significant and not easy to replicate. To be successful in removing incumbents in a payments ecosystem requires immense consumer awareness, significant capital, and a great deal of sophistication in risk management. Both consumers and merchants need to be won over , simultaneously and in large numbers. If this wasn't difficult enough, the payment processors also have ecosystem partners, specifically the banks which issue Mastercard-branded instruments, that have built in financial incentives to keep issuing the company's product, even if a better payment instrument emerges.
Mastercard has exceptional financial discipline. It generates significant returns on invested capital of over 50%, converts over 33% of revenue into operating cash flow and still manages to grow revenue at almost 15% annualized, and has been consistently doing so over the past decade.
I learnt my lesson in underestimating Mastercard, previously selling the business too early. I had invested shortly after the IPO, felt pleased with myself with tripling my investment capital in under 4 years and sold the position in 2009, only to see it go up a further 10x since then. Unsurprisingly, I subsequently bought back in. Mastercard is a position that I won't be selling again.Alibaba
Alibaba (BABA) is another high-quality name that will sit in my bottom drawer forever. I got quite lucky with the timing of my purchase in this business when there were concerns about a possible recession in China in 2016. Alibaba was marked down to fire-sale prices, going as low as the mid-$60s range, which was where I happened to pick up some stock.
When it comes to riding massive secular tailwinds, there is unlikely to be any business with larger tailwinds than this one. Forrester Research estimates that total Chinese e-commerce spend will increase from $1.1 trillion in 2019 to $1.8 trillion in 2022, a compounded annual growth rate of almost 9% per annum, driven largely by the surging growth in the Chinese middle class and strong increases in per capita consumer spending. Alibaba has over 50% share in the Chinese e-commerce market. Further, China's cloud market is expected to grow at a rate of almost 44% p.a. CAGR over the next five years, driven by the cost efficiencies that enterprises gain from shifting enterprise computing from on-premise to the cloud. Alibaba has a significant lead here as well, with over 40% market share in the Chinese cloud computing sector.
There are massive barriers to entry in both of these businesses. The e-commerce business, in particular, lends itself well to a natural monopoly. Merchants tend to gravitate to the platform with the most users, and vice-versa. No one likes to shop in a virtual ghost town. The market share leader in cloud computing infrastructure typically benefits from significant economies of scale that leads to lowest-cost pricing. Once customers start using cloud infrastructure, it becomes a sticky service given it’s a pain to shift over elsewhere.
Alibaba has been growing revenue at a rate of growth of nearly 50%. The company converts more than 33% of its revenue into operating cash flow and has a return on equity of more than 20%. Revenue growth is expected to average greater than 25% for the next 5 years
Alibaba is a long-term play on the growth of China and its rising place in the world economy. Long-term investors can put the trade wars and transitory politics aside - China isn’t going anywhere.MercadoLibre
There is nothing more satisfying than picking a strong, emerging business that is riding long-term secular trends early and then staying on for the ride, and that is exactly what I have been doing with MercadoLibre (MELI). While I got on (and stayed on) the ride for Mastercard and Alibaba when they were already quite large, I caught MercadoLibre when it was still only a mid-cap business with a market capitalization of only $5 billion. Since then, it has grown to a $27 billion business.
MELI leverages the tailwinds of strong Latin American consumer spending growth, as well as the steady shift from offline commerce to online commerce and the shift from cash-based payment to digital. E-commerce is a very small percentage of total commerce in Latin America, barely reaching an average of 3% across the region. This is expected to grow at a fairly rapid clip over the next few years, approaching 10% annualized. MELI has more than 50% of the registered internet users on its e-commerce marketplace and is well-placed to succeed long term. E-commerce marketplaces tend to be winner-takes-all businesses, where the early entrants are able to establish a beachhead of users and merchants that becomes difficult for a new entrant to dislodge. That tends to lead to long-term dominance in a market.
However, the crown jewel of MercadoLibre may well be its payments processing business. The company has a strong foothold in the digital payments market in Latin American. It processes almost $6.5 billion in payments each quarter, doing almost as much in payment volume off-platform as it does on-platform. With investment and a commercial partnership with the likes of PayPal, this is a business poised for great long-term success and one that I won’t be letting go of easily.CSL Ltd.
This is a relatively unknown business in a rather obscure, but very important, industry. CSL's (OTCPK:CSLLY) core business is in blood collection, fractionization, and commercialization of plasma proteins and constituents derived from blood products. This business is one that thrives on economies of scale, in the collection of plasma, the processing and fractionization of plasma, and the ultimate distribution of plasma.
As such, there are inherent barriers to entry for any new entrants trying to break into the market to achieve the necessary scale required to be a meaningful player, not least of which are having the capital required to build out necessary facilities, the marketing, reach and reputation to convince members of the public to provide blood for processing and the necessary regulatory permits to operate blood processing facilities. The long-term trends for the industry are robust. An ageing population will necessitate a higher volume of medical procedures, many of which will require blood transfusion and the rich supply of plasma proteins that CSL helps fractionate. Additionally, increasing incidents of chronic diseases such as hemophilia and hepatitis C also require ongoing blood transfusion and create a healthy, long-term demand for plasma and its derivative products.
This business manages to consistently grow revenues by double-digit percentages and has done so for a long period of time. Returns on invested capital have consistently been greater than 20% for more than a decade. CSL has generated long-term investor returns of 24% p.a. over 15 years. That’s more than 15x return on capital invested at that time. Unfortunately for me, CSL was another great business that I let go of too early, more than 15 years ago. More recently I got back into the business, and I don’t intend to get off again.Adobe
Finally, my list of businesses that I’ll never sell is rounded out by Adobe (ADBE).
The creation of rich, high-definition media for content consumption is a trend that has been accelerating over the last few years. Fast mobile networks, devices with increasing processing and a shift to content monetization via digital advertising have all come together to create strong demand for digital content creation and accompanying analytics and marketing tools.
Adobe is the platform of choice for rich media content creation and editing. The company's Photoshop product has an iconic place in the creation and editing of images, to such an extent that image manipulation is now known more commonly known as having just been photoshopped. Beyond Photoshop, Adobe Premier Pro, Premier Effects and After Effects subsequently followed and took their place as best-in-class video software creation and editing tools.
Given the market dominance of Adobe in content creation, there is an expectation that creative digital professionals entering the workplace have a working knowledge and ability to use Adobe products like Photoshop and Premier Pro to create their content. This expectation is reinforced in the industry and academia, where the training courses for many creative design professionals heavily lean on the family of Adobe products to assist the learning experience of students.
Adobe has averaged revenue growth of approximately 23% over the last 3 years. Its retention of revenue is also very good, with a gross margin consistently near 85% and net margin above 25%. Adobe sports returns on invested capital near 20%, which is exceptionally good. Free cash flow generation is often 30% or higher of the company's revenue, resulting in a business that can largely control its own destiny as far as financing investment and growth.Takeaways
Finding businesses with excellent financial discipline that are riding long-term tailwinds is a recipe for long-term wealth creation, particularly if those businesses are competitively advantaged. Within that subset of businesses, it’s a very rare cohort of businesses that an investor can confidently keep and hold forever. If such holdings do work out, however, they can lead to life-changing wealth.
I’d love to hear from you in the comments about whether there are any businesses that you feel you could hold or plan to hold forever, and which businesses they are.
To see other ideas of high quality, growing businesses that are positioned to be long term wealth creators, please consider a Free Trial of Sustainable Growth.Ideas based on the philosophy of Project $1M, which has outperformed the S&P500 by more than 75% for 2019, and returned 20%+p.a over nearly 4 yearsAccess to Large Cap, Emerging Leader and High Conviction Model PortfolioWatch list that covers a broad universe of businesses with 'unfair competitive advantages' in fast growing marketsExclusive ideas on potential 'Wealth Creators of tomorrow'
Disclosure: I am/we are long MA, ADBE, MELI, CSLLY, BABA. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.