In this book, we elaborate on the key elements necessary for crushing risk to generate steady and healthy returns from equities in India. Our approach is to buy clean, well-managed Indian companies selling essential products behind very high barriers to entry. We call this approach to investing Consistent Compounding, and have seen, both in theory and in practice, that it works. This approach has three key elements—Credible Accounting, Competitive Advantage and Capital Allocation. They are the foundational pillars of Marcellus’s investment philosophy, which will help investors generate healthy returns without taking extra risk (or loading up on beta). The first pillar, Credible Accounting, uses a set of forensic accounting ratios and techniques to identify companies with the least accounting risk and the highest reliability of reported financial statements. Competitive Advantage is the search for companies that possess strong and durable pricing power, enabling them to be leaders in their markets and consistently earn returns higher than their cost of capital. This mitigates their revenue and profit risk. The third pillar, Capital Allocation, is about finding companies that make the best use of their excess returns (the difference between return on capital and cost of capital, akin to free cash flow) in order to grow their business as well as to deepen their competitive advantages. Knowing what stocks to buy using the three pillars is what we call the Consistent Compounding Formula.
