By Compounding Academy
In this issue, we continue our Mindset SQUARED™ Framework series, the structured process we use to identify, analyse, and invest in the world’s best compounding businesses. Today, we move to one of the most important steps in the framework: Analyse.
This is where a company stops being a story and becomes an evidence based investment case. Essentially, we test the narrative using key data.
The Analyze stage helps you look beyond headlines and short-term movements to understand the underlying strength of a business. It focuses on financial resilience, competitive positioning, and exposure to long-term structural trends.
This step separates companies that merely look strong from those that can compound for decades.
Short-term numbers can mislead. Long-term patterns rarely do.
When analysing a business, begin by examining its historical trajectory:
Compounding depends on consistency. Consistency shows up in the trend line, not in a single quarter.
Visa’s revenue, margins, and ROIC have displayed remarkable improvement for more than a decade. Even during economic slowdowns, the business remained resilient because it scales efficiently and requires little capital.
If revenue grows but margins fall or cash conversion weakens, it can indicate that the underlying economics of the business are deteriorating.
At first glance, Labcorp’s top-line performance appears healthy.
Labcorp offers a clear example of long-term margin drift. The business experienced a temporary spike during the pandemic, followed by a return to its downward trend. This does not make Labcorp a poor company, but patterns like this raise questions about competitiveness and pricing power. For long-term compounding, we prefer businesses with stable or strengthening margins.
The Analyze stage is not about forecasting. It is about checking whether the business continues to behave like a true compounder. Professionals look for anomalies: deviations from expected patterns that require further investigation.
A high quality company usually shows stable or improving trends. When numbers buck the trend unexpectedly, something may have changed inside the business or in its competitive environment.
A temporary rise in leverage is not necessarily a warning sign, but it must be understood. In this case, debt increased following the HHI acquisition. The job of analysis is to assess whether this debt level is sustainable and whether the acquisition strengthens or weakens the long-term economics of the business. Some anomalies are risks. Others are signals to look deeper.
In the case of Assa Abloy, our analysis concluded that this was a good allocation of capital and not a concern.
A company can only compound for long periods if its competitive edge is real and durable. This is where you go beyond narrative and evaluate the evidence of competitive strength.
Professionals analyse:
These metrics tell a clear story about competitive durability and moat strength.
Example: Assa Abloy
Assa Abloy’s scale, strong brands, and high switching costs show up in its stable margins, resilient returns, and expanding market position.
Companies with narrow product sets or low switching costs often show weakening market share, falling margins, or rising customer churn once competition intensifies. True moats remain visible in the data.
A company aligned with long-term structural themes has a far greater chance of compounding consistently.
Examples include:
The key question is whether the industry backdrop supports long-term growth.
Example: Watsco
Watsco benefits from recurring HVAC replacement cycles, rising demand for energy efficiency, and the gradual digitalisation of a traditionally manual industry. These forces support steady growth and resilience.
Financials show what the business has achieved.
Management determines what happens next.
One of the most reliable ways to assess management quality is to examine ROIC over time. A strong or improving ROIC indicates disciplined capital allocation. A declining ROIC may signal poor investment decisions or competitive erosion.
It is equally important to examine incentives. When incentives reward long-term value creation, there is often a strong correlation with better returns, healthier balance sheets, and more thoughtful capital allocation.
After major decisions such as acquisitions, professionals analyse the outcomes, not the announcement:
These outcomes reveal whether management created value or merely added size.
Example: Costco
Costco’s long-term record of high returns, stable margins, and disciplined reinvestment of profits to provide value for its customers, reflects a culture focused on sustainable value creation rather than short-term results.
Apply this framework to your own portfolio.
Many of the world’s best compounders such as Visa, Costco, Watsco, and Assa Abloy display the traits uncovered in this stage. Consistent margins, strong returns, durable moats, and alignment with structural trends often show up in the data long before the market recognises them.
Explore these companies in our One Pager Library, Business Quality Assessments, and our Mindset SQUARED Mini Course.
In the next issue, we move from Analyze to Ripping Apart, where we challenge our own investment case, search for weaknesses, and avoid confirmation bias before allocating capital.
See you next time.