The concept: The portfolio runs on two buckets with different mandates.
Compounders
Do you remember the first rule of investing? Don’t lose.
The goal of this category is to secure your capital and let it appreciate over a long-term horizon. It’s the Quality phase of Warren Buffett (after his cigar-butt phase).
The objective is to maximize risk-adjusted return by holding exceptional companies you buy at a good price. Peter Lynch called it Growth at a Reasonable Price (GARP).
The rationale behind this is simple: roughly 4% of stocks generate 100% of long-term market returns.
The longer you hold them, the more important the growth of free cash flow becomes, and the less important the entry PE ratio becomes.
You can invest actively, holding individual stocks, or in a passive way with ETFs.
You may ask: which ones?
Since the best long-term risk-adjusted returns are in quality stocks and large ETFs, you would rather hold the Mag-7 or the MSCI World / Nasdaq-100 than no-growth dividend stocks. You could expect 15-25% per year of growth just on the FCF, plus a rerating of the PE.
Investors who got beaten down on a quality stock may say ‘I’m here for the long-term’. It is a good sentence because in this category, time is your friend, and you’d probably recover if you are patient enough.
Multibaggers
The goal of this category is to get massive gains in a short period of time. Why wouldn’t everybody do that ? Because it’s damn difficult ! You may find:
Growth stock: finding it before everyone else
Turnaround stocks: distinguish which company will recover
Cyclical stocks: correctly anticipate the direction before the actual move
Cryptoassets or commodities: correctly anticipate the direction before the actual move
You can also invest here in an active way, with the holding of individual stocks, or in a passive way with ETFs.
The way you deal with it is with the intrinsic asymmetry of the stock market: what you can lose is limited (max 100%), and what you can win is potentially unlimited. When you are leveraged, you break this asymmetry (generally, don’t be leveraged, especially in multibaggers). The ideal setup is a stock where ‘either I gain a significant amount, or I don’t lose much’. Don’t forget these are riskier stocks.
Some market spots are ideal for this category: small-caps, as they are under-covered, and inaccessible to big money because of illiquidity — meaning they can rapidly become a major shareholder.
Most 10-baggers come from small-caps, and some of them have the advantages of compounder as they have quality stocks, and of a multibagger with the re-rating.
I said you could expect 15-25% per year for the compounders, plus the rerating. For the multibaggers, almost everything is possible here, plus the rerating. It is a reason why I don’t like small-caps indexes. Moreover, the best ones will leave the intermediate indexes to be in the top indexes (nasdaq100, SP500, etc.)
Some stocks compound for so long that you end with a 10-bagger just by sitting on them: if you hold a stock for 10 years with a 25% CAGR, you have a 10-bagger. They are multibaggers in disguise - I still categorize them as compounders.
In this bucket, time may bless you or punish you. And the volatility is quite high (30-70% in a year is normal), you need a stronger stomach than in compounders. And if you’re leveraged, volatility is your enemy.
How to deal with both
In a bull market, multibaggers may capture a significant part of the upside. When a multibagger pays off, it usually compensates for all the losers left along the way. As the portfolio grows, part of the gain stays safe in compounders, and part gets reallocated into other multibaggers. I call this a ratchet effect. It matters because a portfolio has a natural tendency to concentrate, especially toward its multibaggers, giving them a disproportionate size.
In a bear market, capital can be reallocated from compounders to multibaggers to regain exposure to the upside and get strong entry points on beaten-down multibaggers.
Tax matters from the moment you enter a position, not just at exit — always think in after-tax terms.
As the portfolio grows, the natural tendency is to shrink the multibagger percentage and grow the compounder percentage. Above $1M, being 100% in multibaggers feels like madness: why risk losing everything you have for money you don’t need?
My personal portfolio of six figures is designed to run 50% compounders, and 50% multibaggers, though I frequently need to reallocate toward compounders (the ratchet effect).
Questions
This probably raises a few questions worth asking yourself:
Categorize your own positions: which bucket does each one actually belong to?
Are you satisfied with your current allocation between the two?
Is there redundancy in your portfolio — multiple positions doing the same job?
Is there real diversification, or does it just look diversified on paper? Are the underlying theses and key factors correlated?
Do you understand what you hold and why you hold it?
Is each stock you hold actually better than its category ETF?