There is a rule of thumb in investing called the rule of 72. This is a simple algorithm to calculate the time it will take to double an investment. For example, if there is an ASX share growing at, say, 10%. Then dividing 72 by 10 tells you it will double in 7.2 years. You can replicate this the long way in excel to prove it works. This illustrates the power of compound interest and should be a part of any investment decision.
The great caveat here is, of course, that the company will continue to grow at this rate going forward? Therefore, as the future is notoriously hard to predict, we have to use past performance plus a judgement of the future conditions for growth.
ASX shares in investment companies
Magellan Financial Group Ltd (ASX: MFG) is a large investment company on the ASX, led by a fund manager that I personally hold in high esteem. Hamish Douglass has achieved astounding results over the past decade. For instance, he has managed to grow the earnings per share (EPS) at compound annual growth rate (CAGR) of 50.5%.
Over a 10-year period, this ASX share has achieved a share price CAGR of 54.3% up to yesterday. At this rate, any investment today, using the rule of 72, would double in under 2 years. However, will growth stay the same?
Clearly, no one really knows. However, all key personnel remain in place, and the company has embarked on a growth strategy via the creation of a new Australian investment bank. Personally, I think that growth will remain high. Nonetheless, even if it were to falter for a year or two I am still confident this company would double its share price over a 5-year period.
Insurance and financial services
AUB Group Ltd (ASX: AUB) is a mid cap insurance company that has outperformed every other insurance ASX share in year to date trading. In fact, the company has seen its share price rise by 46.2% since 1 January. This is despite the coronavirus pandemic. The company's business model is that of a distributed broking and underwriting platform. Whereby, there are a range of stand alone companies responsible for niche industry sectors. What's more, the FY20 result was the largest increase in underlying net profit after tax (NPAT) since 2013.
The company has achieved a share price CAGR of 14.3% over an 11-year period. Again, using the rule of 72, this means the initial investment would double within 5 years if share price growth continued. Given the consistency of performance and the unwavering direction of travel of this ASX share, I believe the growth rate will continue.
Foolish takeaway
The rule of 72 is a good guide to how long it will take to double an investment based on a consistent level of growth. Like many other metrics it doesn't provide you with the answer, it just allows you to ask more sophisticated questions. For example, what would prevent an ASX share like AUB Group from achieving its CAGR of 14.3%? Moreover, is there still enough room in its addressable market for it to continue to grow at this rate?
Personally, I am confident that the two companies above will continue with a level of share price growth high enough to double an investment within 5 years.
