The power of compounding – a shaggy dog story
World in Motion – Global equities blog

The power of compounding – a shaggy dog story

The British government has a scheme whereby every year you can set aside and invest a small amount of money on behalf of a child, tax-free. The child receives the money from this Junior ISA (Individual Savings Account) when they turn 18. Introduced in 2011, Junior ISAs were designed to encourage the concept of saving and had an annual limit of £3,600, which increased more or less in line with inflation until 2020 when it rose to £9,000.

Coincidentally, my daughter was born in 2011 and is now nine, so we are at the halfway stage of the life of her Junior ISA.
Every year we have been in the fortunate position of being able to invest the maximum possible in her Junior ISA, and every year we have bought shares in Nestle – a global player with very diversified income streams operating in highly resilient sectors such as confectionery, pet food and coffee – reinvesting the dividend income too. Most importantly, the dividend has never been cut in Swiss Franc terms for as far back as we can establish. In fund manager speak it is a “defensive” company. Off the record, we might almost call it boring!
The thinking was that, having started buying shares in 2011, Nestle would probably still be a going concern in 2029, at which point our daughter could hopefully use the proceeds to fund her way through university in the UK, where tuition fees now cost up to £9,000, or spend it on something more fun. The aim was never to get rich, merely to have a little chocolate-coated nest egg that would protect against inflation – with Nestle the makers of Smarties (Rowntree introduced the product in 1937), what more fun way is there to learn about investing and the power of compounding than combining it with a product that all children love? We were never trying to find the next Alphabet, Apple or tech behemoth – in fact Netflix had an appalling 20111 , perhaps we should have bought the dip!
At the time of writing, Nestle shares are priced at 116.24 Swiss Francs – an all-time high (they were around 38 in 20112 , we’ll call it trebling if we’re being a mite generous). Fortunately for a global investor, they are also near all-time highs in US dollar terms; but interestingly for a UK investor, such has been the recent strength of sterling that in UK terms the stock peaked at the end of September 2020, although it’s not far off this now. So lesson one is that currencies matter – although for a business such as Nestle, this is the case much more in the short term than in the long run.
We were investment heroes to our daughter the day after the Brexit referendum, given that she had 100% of her net wealth in non-sterling denominated assets – a flagrant violation of any sensible investment policy as regards diversification of assets. And this is lesson number two: the merits of diversification are possibly overblown, at least at portfolio level. Yes, emerging market economies will (or should) grow faster in the long run, but who knows where the next crisis will come from? (Yes, I know, Argentina is always a good bet.) The Chinese economy has obviously been a huge success story over the past decade, but it wasn’t necessarily written in the stars. So it is better to have a portfolio of great brands which sell at a significant premia to the price they cost to produce, because the consumer likes the way they taste, the way they make them feel, the memories they evoke.
The value of our daughter’s Junior ISA currently stands at just under £76,000 (this year’s ISA not having been purchased yet), relative to £49,000 invested. That’s a 54% return overall, net of fees and transaction costs (this is by no means a perfect experiment as transaction dates vary wildly year by year, etc, making it slightly tricky to annualise the return). That said, the £27,000 gain is exactly the sum necessary to fund a three-year university course at the £9,000 annual fees level – so not enough to retire on, but miles better than a bank account. It has done the job it was designed to do, even during a global pandemic.
What of Nestle itself in the interim? The truth is that the stock’s real glory days of outperformance came in the aftermath of the global financial crisis of 2008, when it did well relatively because of its “defensiveness”, and was still trading off the echo of the wildly successful Nespresso story. In fact, of the 216% UK sterling total return that Nestle has delivered since 20113 , almost half has come from multiple expansion and currency gains rather than earnings growth and reinvested dividends, according to work by broker Jefferies.
On a personal level, despite having a Nespresso machine and eating the occasional KitKat (Rowntree introduced the product in 1935 and at times in the 1920s and 1930s it must have been like being a kid in a sweet shop such was the pace of confectionery innovation – Snickers launched in 1930, Mars bars in 1932, Aero in 1935, but I digress), it seemed as though the brands were in danger of losing relevance in the internet age as we discovered mobile phones and online shopping.
But the great thing about companies, particularly in industries such as consumer staples, which aren’t hugely capital intensive is that they can reinvent themselves. There is no such thing as a tired brand – only tired brand managers. Although Nestle is a supertanker, there have been positive signs of reinvigoration since Mark Schneider became CEO in 20174. The company is more focused on coffee, pet food and nutrition, which are some of the fastest growing areas within consumer staples and where Nestle has terrific brands, significant competitive advantages and uses its scale and muscle to outspend the competition in terms of R&D, sales and marketing.
Of particular note is that pivot towards pet care. This is now Nestle’s second biggest division at just under 20% of group revenues and profits – only five years ago it was only the fifth biggest category for the company. Again, this is a move that chimes with personal experience. Like many others around the globe, our family grew in size in 2020 as we welcomed a loveable Cavapoo puppy into our household. And if we aren’t costumers of the Independent Vetcare Group, Europe’s largest veterinary services group in which Nestle has a minority stake5 , we can at least report one very happy consumer of natural pet food brand Lily’s Kitchen, which Nestle acquired last year.6
So at the halfway stage of the life of this particular Junior ISA, one cheer for the government for instituting a sensible incentive to save, another for the power of compounding for funding a little girl’s education, and one final bark from Monty the Cavapoo in appreciation. Like him, Nestle shares are for life not just for lockdown.
2 July 2021
David Dudding
David Dudding
Portfolio Manager, Global Equities
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July 2021
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3 Bloomberg, 2020
4, 29 June 2016

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