Compounding Thousands Into Millions: The Art of Identifying Winners Early.
Update
Note: I’ll be uploading the video to Spotify next week when I get good internet access.
Edited by Brian Birnbaum.
Over the past few years in the stock market I’ve compounded a few hundred-thousand dollars into millions of dollars.
As Charlie Munger aptly put it, the recipe is simple, but not easy: I identify and concentrate my investments in companies highly likely to exponentiate free cash flow per share before the market does; and, as Warren Buffett aptly put it, I intend to stick with them for the duration of my favourite holding period–forever.
All my highly concentrated multi-bagger investments have one thing in common: rapid free cash flow per share growth. As Jeff Bezos put it, investors can’t spend margin, but they can spend free cash flow.
It’s a simple fact that stock prices track free cash flow per share over the long term. Ultimately, the best way to create wealth in the market is learning to identify companies that exponentiate free cash generated per share before the market does.
The graph below shows how rapidly Spotify’s FCF/share has grown since June 2023. The depicts the same for both Hims and Palantir. Not too long ago both Palantir and Spotify were discarded by the market as bad businesses; now, while we hear chatter about valuation, it inevitably comes with the caveat that they’re fantastic businesses. They’re also among the top performing stocks in the entire stock market, with my Spotify and Palantir investments up over 6X and 11X, respectively.
Hims is my latest big bet, with my original purchase up 2.6X - although I’ve been averaging up lately, with my latest purchase coming in at $37 per share. As you can see in the second graph, free cash flow per share growth is also satisfactory thus far.
A company that wants free cash flow per share growth must also increase operating leverage, and increase it quickly. A company’s operating leverage rises when revenue growth starts meaningfully outpacing costs, ultimately yielding more FCF/share. Although the market is an efficient information processing machine in the long term, it’s a voting machine in the short term. And regarding technology in particular, things are not always what they seem.
It was just a few years ago that the market thought Spotify was a dying music app, trading at $97.50. Informed by my first-principles understanding of value creation processes in the network-defined economy, I understood that Spotify’s value was moments away from appearing in the numbers for the first time in two decades of existence.
With a large network of highly engaged users, you can meaningfully increase operating leverage by deploying additional verticals at a marginal cost. Deploying the new podcast and audiobook verticals and focusing on cost-efficiency drove Spotify’s cash from operations to new heights, per the graph below.
Outside observers tend to believe that these blowout quarters are a one-off or a fluke because they don’t understand the origin of this outperformance on a first-principles basis. Over the long term, financial performance tracks culture. The latter defines how people work together within an organization and who they permit (i.e. the quality and commitment of their teams), which broadly determines their collective fate.
In turn, Spotify’s culture is only improving. As a result, we’ll likely see continued financial outperformance.
Spotify’s core organizational ability–typically shared across all world-class businesses–is delighting end consumers in a way that’s increasingly harder to replicate while producing cash. They won’t stop at podcasts and audiobooks; Spotify has plans to deploy an endless stream of additional verticals. They’re now prepared to solve big problems shared by creators and fans alike. In aggregate, Spotify’s market cap five years from now will be a rough reflection of the aggregate volume of problems that it solves for marketplace participants, and I anticipate that said volume will grow exponentially.
Two years ago the world also thought that Palantir was a glorified consulting company. However, as I explain in my 2022 Palantir deep dive, their software is foundational for the successful deployment of AI in the West. Back then, the odds of developing a method of frictionless distribution were palpably high. As I “predicted,” Palantir’s cash from operations has risen sharply as a result of LLMs (large language models) making the distribution and operation of Palantir’s software much easier, as you can see in the graph below.
I use scare quotes above because the future isn’t known; rather, we can bet on vehicles that are highly likely to overcome obstacles along their way. I saw clearly the relevance of Palantir’s software and, assessing their culture, understood that the odds of them productizing their software were high enough for me to place a concentrated bet. As is the case with Spotify, Palantir’s future financial performance will be broadly dictated by the evolution of its culture, which is currently extraordinary.
As with Hims at present, for years after I identifying these companies the market spent years spinning stories to justify their stagnant stock prices. But eventually, stock prices began tracking free cash flow per share as Palantir and Spotify continued to execute successfully quarter over quarter. Further, as we saw in my Netflix deep dive, the market can send the stock of an extraordinary company down over 70% in just a month or two, only for it to then bounce back 420%+ once the 2022 narrative was dispelled.
All this is to say that the market tests your conviction repeatedly to extents that will push your psychological limits. Many people ask me whether it’s easier to manage large declines when you’re up 10, 20, or 30X on a position. The answer is no. You only get better by studying businesses intensely over time and learning to differentiate between the decline of a stock price and the decline of a company’s earning power.
I’ve been holding AMD for over ten years now. Back in March 2024 my original investment was up 50X. Over the past year, my investment has been cut in half. The majority of market sentiment suggests the company is done. I’ve seen similar situations time and again over the past decade.
The market always finds ways to test your conviction and sell you extraordinary companies at a steep discount–a phenomenon easily recognized as an oxymoron when discussed in theory but, in real time, more often interpreted as a paradox by market participants whose emotions are tested as prices decline. In lieu of the thousands of hours spent learning about semiconductors and AMD’s tech roadmap, I’d have no chance of holding onto my AMD shares.
Today, I’m more convinced than ever that AMD will be my first 100X investment.
It’s with this in mind that inveterate investors understand why identifying companies likely to exponentially increase free cash flow per share is a highly intellectual and psychological game. You have to understand the businesses in question better than the market does and persist in your thesis through severe, elongated, and emotional tests. It’s one thing to be confident in your thesis for a month and another to be confident for years while the market tries to “prove” you wrong in the form of declining stock prices, as depicted above. Losing half of your investment on paper after you’ve mentally declared victory isn’t easy either.
The point is that there is no quick way to create wealth in the stock market. Although the above investments have produced considerable wealth relatively quickly, they are the result of an intense learning journey over the past decade. Every day that I wake up I dedicate my energy to learning something new. I relentlessly study companies, take notes of everything that I read, and write my thoughts down in order to stress test them and improve my thinking process over time.
Much in the way that stock prices track FCF/share over the long term, over the long term, your returns will tend to broadly track your intellectual, psychological, and spiritual development.
I am especially drawn to situations and fields of knowledge that are stigmatized; alpha is most easily found where most don’t dare to look, and such pockets of taboo knowledge arise frequently. The market will often label previously lauded companies as un-investable. Industries worldwide tend to bury knowledge that presents an existential risk–as is often the case with the healthcare industry. The relentless pursuit of knowledge beyond the pale lead you to life’s most asymmetric opportunities.
Mechanically speaking, in order to improve your ability to spot companies highly likely to exponentiate free cash flow levels, you must read annual letters and quarterly conference call transcripts. You must take notes and record your thoughts. As you do this for a growing number of companies over time, your brain will build a neural network that will be able to differentiate with increasing accuracy the best companies from the bad and, more importantly, mediocre. Eventually you’ll see an extraordinary company that the market is pricing highly pessimistically–and that will be your opportunity to create enormous wealth.
I offer two tips: read my 50+ deep dives and hundreds of quarterly updates for free, available in my blog and other channels like Youtube and Spotify, and/or take my Tech Stock Goldmine course. In this course I teach you everything that I have learned over the past decade that has enabled me to create considerable wealth in the stock market, in under 2 hours.
It’s an elegant and powerful framework that has enabled over 400 students to date to acquire all this knowledge with a small fraction of the effort that it has taken me to do so. You can obtain lifetime access to the current and all future versions for just $350 below.
Until next time!
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Many thanks, 100% agreed. Conviction cannot be bought, it can only be achieved after long time studying the company, understanding its business from several directions and learning to read between the lines. So far I believe I’ve only achieved that with three companies. Two of them are my biggest positions and one I have parted ways with. Luckily one of these three companies is Hims. Currently working to reach understanding with several companies, but far from being there yet.