Non-Linearity: The only way to build wealth

We are raised in a linear environment – you graduate from class 10 to class 11, your salary at your job increases in a linear manner – even in our beloved sport Cricket, linearity shows-

every run scored is added linearly. It’s in this linear preferring world that Equity investors, fund managers, and me are looking for non-linear superlative returns.

Our mind accepts linearity – if someone gives me two choices:

1) Show up to work and make 10 Rupees every day, and

2) First day of the month I get paid 10 paise and earn double the next day and so on.

End Result:

1) Choosing option 1, one could make Rs 310

2) Choosing option 2 one could make Rs 10.74 Cr

Well, that’s non-linearity for you, no one is going to give me Rs 10.74cr for a month’s work and is on the verge of unbelievable, non-linearity works in a way that most of us can’t comprehend it. Yet there are so many examples in the investing world where businesses could achieve non-linear exponential growth and as a result investors made superior non-linear exponential returns.

Let me tell you a story of non-linear growth. A small Pathology lab out of Delhi starts expanding its business by going to the outskirts of Delhi NCR in a linear and understandable manner, something that the mind can easily comprehend and understand; then the promoter family brings in a seasoned manager to expand the business and then the non-linear exponential growth happens. The small pathology from Delhi goes national and starts making inroads into states far away from its comfort zone of NCR to places. From then on, the growth and money come in a way that is non-linear and the regular linear mind might not be able to believe. The pathology lab then starts providing value added service like one day results and home collection which adds to the competitive advantage over small time pathology labs and increases the profit pool in an exponential way. With the free cash flow, this pathology lab then goes on to buy small, localized chains and labs. This makes the growth totally non-linear and thus the profits and cash flow too become non-linear, and what the shareholders get is obviously serious wealth creation – one that the linear mind might not be able to comprehend.

The above is not just a fictional story but has played out in front of our eyes in the later half of the first decade, and I am sure there are going to be these non-linear business growths in abundance in the next decade.

Why is non-linearity so difficult to understand?

The average speed in Indian highways is around 45-50 km/hr, so approximately it would take you 5 hours to complete a journey of 250 kms. Now let’s say you start at 06:00 AM with your family to cover 250 kms, you should reach by 11:00 AM.

Not that simple. You start at 06:00 AM, your first break happens at 07:00 AM for breakfast, and you add 1 hour to your travel time linearly. Then you drive for the next two hours; so far you have covered 150 kms in 4 hours and your average speed comes down to 37.5 km/hr. Now it’s 10:00 AM, you take a coffee and bio break, that’s half an hour added- this is how where the calculations go beyond the linear mind.  You cover the next 100 kms in 2 hours as per the average speed on Indian. But now instead of 11:00 AM, you reach at 12:30 PM, so you covered 250 kms in 6.5 hours, and with that the average speed is reduced to approximately 38 km/hr. Well non-linearity works like this, after a while the human mind doesn’t think too much about these calculations. Non-linearity in good businesses works the other way— where growth and cash flow become exponential which is unusual to the normal mind that has been born and raised in a linear world.

The usual volatility of a Multicap PMS over 5 years periods is between 15-20%, which means if you plot the returns of the PMS, they will certainly be a non-linear graph and from time, might test your patience and nerve to stay invested in the portfolio. A mind that is not able to comprehend this non-linear format of price movement will come out of the portfolio too soon and miss out the compounding returns that a good multi cap PMS would have given over the 5 years which would be in the range of close to 20% and that means every rupee invested would be 2.5 Rs over that 5-year period.

Let the romance of non-linearity not lure you into sub-par businesses – which will destroy your wealth in a fashion that the mind won’t comprehend. We, at PMS AIF WORLD, work with you in choosing the best fund managers for you so that your wealth grows in a non-linear and exponential way.