In the past few years, compounders—companies that can steadily compound their earnings and equity value over long periods of time—have captured investors' attention.
The allure of compounders is easy to see: Day traders have to find new trades all the time. Event-driven investing is less hectic than day-trading, but event-driven investors still have to search regularly for new ideas. By contrast, buying compounders necessitates no endless search for new investments. Instead the compounders naturally grow, doing the investor's work for him.
As elegant as that is in theory, it's not always easy in practice. Some companies that look like long-term winners turn out to be dogs. Valeant and Ocwen Financial are two faux-compounders that have imploded recently. The opposite can also happen: some apparent dogs turn into long-term winners, with their success being largely unforeseeable. Here are three examples.
Atlantic Tele-Network (ATNI) acquired Guyana's telephone monopoly in 1990. During the 1990s, it acquired other telecom assets in the Caribbean before splitting them off into a separate public company in 1998. Since then, ATNI's stock has appreciated 2150%—a 19% annual return over 17 1/2 years. Dividends increase the annualized rate of return to 24%.
Two acquisitions are responsible for most of this prodigious appreciation. In 2005, ATNI acquired Commnet, which operates "wireless base stations" in sparsely populated areas. It paid $59 million for Commnet, which will produce $75 million of EBITDA this year.
In 2009, ATNI acquired 900,000 wireless subscribers from Alltel when it merged with Verizon. ATNI paid $200 million for the subscribers, invested another $100 million in the acquisition, and sold it to AT&T for $800 million in 2013.
But before 2005, there was nothing in ATNI's history that suggested it was capable of making successful acquisitions. From 1990-98, ATNI's stock lost 60% of its value. The Caribbean telecom company that was split off in 1998 later went bankrupt. In 1998 and 2000, ATNI bought two Haitian telecom companies that it had to write off in 2001. In 2001, it invested in a bandwidth-trading company that filed for Chapter 7 bankruptcy less than a year later. Other money pits included a Guyana-based call center and a collect-call business. The entrepreneurial acquisition strategy that eventually made ATNI a home run incinerated money for years.
Tractor Supply (TSCO) operates "rural lifestyle retail stores," i.e. stores that cater to hobby farmers. Since its all-time low in late 2000, TSCO stock has appreciated a phenomenal 18,700%, or 40% annualized over 15 1/2 years. The company has achieved these returns by retaining most of its earnings and reinvesting them at high incremental returns.
But before 2001, TSCO's results suggested it was a below-average business. From 1995-2000, TSCO grew earnings per share only 6% per year despite retaining all earnings. It earned $70 million from 1995 through 1999, yet earnings were only $4.25 million higher in 2000 than in 1995. From 1994 to 2000, TSCO stock fell 60%.
In early 2001, soon after the stock began its upward rampage, "Charlie479" from Value Investors Club wondered if TSCO's business model doomed it to poor returns:
It seems to me that it's competitive strategy is precisely the one that anchors it to mediocre returns on capital. If the stores' attraction (indeed, the key to their 5-10 year survival against the big boxes) is the hard-to-find, slow-turning item that the Home Depots or Lowes won't stock, then a large inventory is a permanent part of this company's operating model. This large working capital requirement translates into high capital requirements for the business... I think the economics of the business will produce only average market returns over the long term.
Ball Corporation (BLL) makes aluminum cans. Since March 2000, BLL stock has risen more than 2000%, or 22% annually. Over time, the can-making industry has gradually consolidated into an oligopoly, increasing the pricing power that BLL and its competitors enjoy. Notably, BLL has been active in acquiring its rivals, so it's been both an instigator and a beneficiary of this trend.
Consolidation's benefits didn't materialize immediately, however. BLL and its competitor Crown, Cork & Seal made numerous acquisitions during the 1990s, yet in early 2000 BLL's stock traded at a price it had first reached in 1985. Even including dividends, the stock barely kept pace with inflation over that fifteen-year period.
Another thing these three companies have in common, along with the improbability of their stock-market performance, is that they've all benefited from multiple expansion. At their 2000 lows, BLL and TSCO traded at 5.5x trailing free cash flow and 4.5x trailing earnings, respectively. Today they trade at 20x and 27x this year's estimated earnings.
ATNI traded at less than 3x earnings in 1998. Today it's difficult to value because it owns a mix of businesses that produce steady earnings and asset-rich projects with minimal reported earnings, but one investing pitch suggests that the market is valuing ATNI's operating businesses at double-digit earnings multiples.