In this article I want to unpack one of the frameworks I use when thinking about wealth and how it has transformed how I invest.

Once you understand the true nature of wealth, it becomes much easier to identify which companies are actually positioned to create it.

What Is Wealth?

My framework for understanding “wealth” has been influenced by British physicist David Deutsch.

For Deutsch, wealth is the ability to create transformations.

Wealth = Transformations

In other words, wealth is the ability to take lower-value inputs and convert them into higher-value outputs.

The bigger the transformations, the greater the wealth created.

Now that we know what wealth is, the question is, how is it generated?

How Wealth Is Generated

Wealth is ultimately a function of 3 variables: knowledge, capital and execution.

Wealth = F(Knowledge + Capital + Execution)

Below we’ll unpack each.

• 1. Knowledge

Knowledge unlocks new possibilities.

It is the ability to identify the tools, methods and combinations necessary to create transformations.

The more knowledge you have, the more transformations you can create.

And since knowledge is infinite, wealth is infinite.

However, knowledge alone isn’t enough. Once you know what to build, you need the resources to build it. You need capital.

• 2. Capital

Capital moves knowledge from theory into the practice.

It is the ability to mobilise the labour and resources necessary to create transformations.

We can say then that capital is a claim on potential future transformations.

Over time, knowledge reduces capital requirements.

As new knowledge emerges, scarcity shifts. Transformations that were once scarce become abundant and/or obsolete.

For example, think about how smartphones collapsed dozens of specialised tools into a single device, from calculators, to cameras, to music players to etc.

However, knowledge and capital aren’t enough. Once you know what to build and once you have the recourses to build it, you need to make it happen. You need execution.

• 3. Execution

Execution is the application of knowledge and capital.

It is the ability to build systems, processes and organisations that are necessary to create transformations.

It is what turns potential energy into kinetic energy.

Without execution, knowledge stays theoretical and capital stays idle.

Applying The Framework To Investing

Through the lens of this framework, it becomes perfectly clear which companies we want to invest in.

We want to invest in companies that consistently generate new knowledge, intelligently deploy capital and relentlessly execute at scale.

In practice, that means we want:

• Companies with a culture of experimentation that invest heavily in R&D.
• Companies that allocate capital with discipline.
• Companies with operators who can effectively orchestrate the entire process.

This explains the success behind the biggest and most enduring companies in the world.

Asking The Right Questions

This framework also clarifies the questions we should be asking as investors.

Instead of asking “What is this company worth today?” we should ask “What new transformations can this company make possible?”

Instead of asking “How big is the market today?” we should ask “To what extent will the company’s transformations expand the market?”

And instead of asking “What happens if growth slows?” we should ask “Does this company have an engine that keeps creating and applying new knowledge?”

When you ask better questions, you can identify better companies at creating enduring wealth.

Summary (TL;DR)

Wealth is the ability to create transformations.

Knowledge determines what can be done. Capital determines what can be funded. Execution determines what will be done.

Investing is the process of directing capital to the companies that best align these three forces over time.