Tuesday, August 24, 2010

10% FCF Yield

From an interview with Glenn Greenberg this past spring:

If you could buy a decent - not great, but decent quality business with a 10% free cash flow yield – my experience is that you would rarely lose money. A decent business is going to grow –maybe not really fast, but if you can start out with a 10% free cash flow yield and it is going to grow at some modest rate, 3-4%, you are going to end up with a pretty decent investment – a theoretical 13-14% rate of return.

Think about how that compares with what anyone says the market can offer over a given period of time, which is between 7-8%. So the question is why should a decent quality or good quality business be priced to give you a 13-15% return when the market is priced to give you a return of about half that?

What Greenberg says about "decent" businesses also applies to the better franchises. You may not be able to pick the great ones up at a 10% FCF yield but their superior and durable economics will produce better than market returns at lower risk.

You can't compare returns between investments without adjusting for the risks taken to achieve those returns.

The lower risk profile matters.

Adam

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