How to Turn $50,000 into $900,000,000

I have my nose buried in another biography detailing the life of Shelby Cullum Davis, who turned $50,000 into $900,000,000. To build this fortune, Davis invested in a specific industry within the stock market. He referred to the stocks he invested in as “compounding machines.” Yes, another post about compounding.

In the introduction to the book I found this:

“The most informative source on Davis was his namesake, the fund manager I was interested in writing about in the first place. Born in 1937, Shelby had grown up watching his father analyze companies, tagged along to visit CEOs, learned how money went forth and multiplied, as determined by the Rule of 72. That simple calculation put an exciting spin on the familiar adage penned by the overfed founding father, Ben Franklin. Not only was a penny saved a penny earned – a penny compounded 25 times was $671,000.

To his son, Davis passed along his infectious passion for owning shares in carefully chosen companies (he called them “compounding machines”), his conviction that owning the best compounding machines would lead to unimagined rewards.”

This is obviously my kinda book. Here’s the formula:

Compounding machines = unimagined rewards

“Most people make money to spend money. Davis made money to make more money.”

Davis didn’t start out investing and had several jobs throughout his career. In his last “job”, he got involved with the insurance industry and started to realize how powerful insurance companies were with regards to compounding. At the age of 38, he quit his job and started investing using $50,000 of his wife’s money. He compounded this $50,000 into $900,000,000 in 47 years.

When Davis left his job in 1947 to begin his compounding journey, he faced the following financial environment:

“In another example of how financial institutions were spared the rigors of competitive free enterprise system they financed, all banks paid the same low-ball interest rates to depositors. The fix was in, imposed by the feds to guarantee bankers a source of cheap capital they could lend out at much higher rates, producing a favorable “spread.” The wider the “spread,” the greater the bank’s margin of profit and safety, and the less chance it would fail. Bankers could work less, keep bankers’ hours (10 am to 3 pm), and play more golf.

Meanwhile, the interest paid to depositors, minus the taxes paid on interest, didn’t come close to beating inflation. That being the case, the savings account was guaranteed to deplete wealth. Year after year, dutiful savers lost money and rarely complained about it.”

Sounds kind of like things are today, doesn’t it?

So he focused on undervalued insurance companies because…

“Underneath the drab earnings, the insurers’ portfolios were merrily compounding, as bond interest and mortgage payments rolled in. These bonds and mortgages in the insurers’ possession were bought with customers’ money. Assuming the unexpected claims didn’t deplete the portfolio, an insurer could amass a gigantic hidden asset that someday would belong to the shareholders. Patient investors could wait for the hidden asset to grow, expect other investors to discover it, and then bid up the price. Other people’s installment payments, plus interest, then became their own life savings instead. This shareholder alchemy required no boiling cauldrons, potions, amulets, or magic words.”

Instead of building his own compounding machine like I have done, he simply bought shares of stock in compounding businesses. I have built up a portfolio of income properties. These properties provide monthly income that can be reinvested. Davis bought insurance companies because they had monthly income from policyholders that could be reinvested into bonds, mortgages and other income producing assets.

He realized the monthly income stream to the insurance companies provided a massive opportunity for compounding within the companies themselves. By buying the stocks of these companies, he got a free ride. The compounding installment payments by the policyholders to the insurance companies created his $900,000,000 fortune.

I found a few other interesting reasons why he found insurance so lucrative:

“Insurance companies enjoyed some terrific advantages, as compared to manufacturers. Insurers offered a product that never went out of style. They didn’t require expensive factories or research labs. They didn’t pollute. They were recession-resistant. During hard times, consumers delayed expensive purchases (cars, appliances and so on), but they couldn’t afford to let their home, auto, and life insurance policies lapse.”

According to Davis, the best compounding machines…

– offer advantages over other businesses
– have products that don’t go out of style over time
– don’t require expensive overhead (factories/research labs)
– aren’t bad for the environment
– are recession-resistant
– are still needed by consumers during hard times

“By owning insurance stocks, he enriched himself far more than highly paid executives who’d made insurance their career.”

Davis made more money owning insurance stocks than he would have as a highly paid insurance executive. Take a few minutes and think about this, because it’s extremely important. More than likely, you can make more money investing in a specific niche than you can working in the same niche. This might mean you can make more money investing in real estate than you can selling real estate.

You’ve probably heard the old saying, “You make more money selling the shovel, than you do using the shovel.”
Well, Davis re-wrote this… “You make more money buying shares in the shovel company, than you do selling the shovel.”

I finished my last post titled, How to Make Thy Money Multiply, with the following written by Lowell Miller:

“What is needed is a total investment process that harnesses the power of compounding in a positive way, that’s pervaded by compounding, that uses the compounding principal to create value in a multi-dimensional way. A process that uses compounding intrinsically – not just after the fact to arrive at a performance calculation.”

Shelby Davis demonstrated this total investment process by buying shares of businesses that were compounding machines. This goes to show we have two choices:

1. Build your own compounding machine.
2. Buy compounding machines.

Well, I guess there is a third option too:

3. Build your own compounding machine and then use the income to buy compounding machines.

 

1 Comment

  • Mark Evans DM

    Reply Reply September 26, 2016

    Great post Rob.

    Spot on.

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