If you have read the infamous bestseller "Rich Dad Poor Dad", you would know that Robert Kiyosaki often preaches about acquiring assets and having the money work for him.
But what he didn't say in his book is how to build a compounding machine. The concept is relatively simple - acquire assets, generate cash, deploy capital, reinvest, repeat.
It may sound simple but the truth is far from it. Here's a 3 step beginner's guide on how to build your own compounding machine:
Step 1: Focus On The Cash
- Cash flow is your oxygen. It pays the bills and gives you room to invest
- Cash flow is different from profit. For example, you might see a 20% gain in your Bitcoin but because the profit is mostly on paper so unless you sell it, you won't have cash to pay the bills
- You could generate cash flow by creating a side hustle, working a part-time job, investing etc.
Step 2: Optionality
- Plenty of people have cash but they have little choice of what to do with it. You think you have capital allocation options until the competition forces your hand
- If you own a restaurant and local competitors suddenly halve their prices, all your plans go straight out the window
- The same thing can be said if you own shares of a public company that gives out dividends. When competitors pop out, they have to either take on their rivals while declining margins or risk losing market share which will hurt your cash flow (dividends)
- That is why competitor moats are so much more important than industry growth. A business largely protected from the competition will have the capital allocation choices others lack without constantly having to react to whatever the competition is doing
Step 3: Finding The Right Place For Your Cash To Go
- A niche market, particularly an unexciting one that isn’t really growing, is likely to be more insulated from competitive forces
- However, in order to grow, you must either expand the niche or diversify. Both are equally hard to do
- That's why conglomerates run by great capital allocators (like Berkshire Hathaway) are so powerful. Cash from one asset can be diverted to another with better opportunities
- To illustrate how powerful this concept is - consider you have a business that is valued at RM15 million (15x free cash flow) with all annual cash flow used to buy another business for 8x FCF
- What are we left with after 10 years?