Power of an Asset’s Value Compounding Annually

In yesterday’s The Upshot section of the New York Times, there was an article titled Sterling to Reap 15,900 Percent Return on Sale. From the article, “Sterling bought the Clippers for $12.5 million in June 1981, according to some reports, and he’ll get a tidy 15,900 percent return over 33 years, an annualized rate of 16.6 percent.” Think about that for a second: turning $12.5 million into $2 billion is amazing (assuming the sale goes through). That’s the power of an asset compounding annually over an extended period of time.

Let’s take a look at an example startup with revenue doubling every year:

• Year 1 – $1,000,000
• Year 2 – $2,000,000
• Year 3 – $4,000,000
• Year 4 – $8,000,000
• Year 5 – $16,000,000

At some point the law of large numbers kicks in and it becomes much more difficult to sustain the high growth rates. If you assume it’s a technology company valued at four times revenue, the value of the company increased from $4 million in year one to $64 million in year five — impressive appreciation. The takeaway is that sustaining a high growth rate over an extended period of time is one of the best ways to build value. Albert Einstein’s famous quote rings true, “Compound interest is the eighth wonder of the world. He who understands it, earns it … he who doesn’t … pays it. (source)”

What else? What are some other thoughts on the power of an asset’s value compounding annually?