Invest in the Best

The main part of the book covers the essentials of what together constitute a superior investment. These include inter alia growth, profitability, returns on capital and equity, and cash flow. (Location 114)

A discussion follows about the desirability of a business being predictable to a higher than normal degree of certainty. (Location 116)

Foremost among them are discipline and patience. For me, discipline comes from investing only from the perspective of a businessman. Patience, however, is the not-so-slight matter of how you are wired. (Location 128)

Life is a random walk and opportunities crop up in the most unexpected ways at the most unexpected times. When you see one, act. The window of opportunity will not necessarily be open for long. (Location 213)

I learned that when investing in a business, it is a good idea to check out the equity ownership of the people running it and how much they are drawing in salaries. If they have a large amount of personal wealth tied up in the business and behave frugally, it is more likely that they will act like owners to preserve their wealth (and yours with it). (Location 229)

The starting point is to identify particular types of company as investment candidates, i.e. those with the most predictable business models, then to value them. If a business model is not predictable to a high degree of certainty, how can you value it? And if you can’t value it, how do you know if the stock market price is offering you an investment proposition or not? (Location 281)

methodology. It showed us the overriding importance of concentrating on the economics of a business and discarding those companies that do not stack up against a set of predetermined criteria. This was a massive step change in our thinking: (Location 293)

At any one time, I will have a number of businesses on my watch list that have passed the first ‘go: no-go’ assessment but where I am waiting for an appropriate pricing opportunity. (Location 340)

I look for a business where I think I can understand the product, the competition and what might possibly go wrong over time. I want to invest in a great business franchise with high castle walls and a piranha-infested moat with a drawbridge over it. This is the superior competitive advantage mentioned in the list above. (Location 360)

The lesser the presence of these basic competitive forces, the greater the profit potential of the business. (Location 364)

Having said that, if you have big enough barriers around the franchise, you don’t need the ultimate management team to run it. (Location 396)

above, the next step is value determination. (Location 400)

I try to decide what seems to represent an appropriate entry price for what I have seen up to that point based on my assessment of what I think the business will earn over the next five, ten or more years. (Location 400)

change in value = units of capital × growth rate × (return on capital – cost of capital) (Location 426)

Indeed the higher the rate of growth, the more value is destroyed. When the return on capital equals its cost, no value is created or destroyed by growth, which is obvious if you think about it. Beyond the hurdle rate of a 10% return, value is increasingly created with higher rates of growth and profitability. (Location 497)

Cash flow only really becomes valuable once it becomes distributable. Business owners cannot spend factories, stock or debtors. This means the growth that is produced by businesses that simply grow their assets other than cash, yet stand still in value, is worthless to investors. (Location 563)

A company that grows its revenues, earnings and capital base rapidly will be worth more than a slow growing company as long as they are both earning the same rate of return on invested capital and as long as this rate of return is materially higher than the opportunity cost of capital. (Location 658)

Operating margins could be declining in one business, expanding in the other. The ratio of sales to assets could be expanding in one business, declining in the other. If the two were retailers, the key difference might be in stock turnover, debtor days or asset utilisation. (Location 667)

Given equal growth rates in revenues, companies that earn a higher return on their capital relative to their cost of capital should command higher stock market values. It follows then that both growth and profitability should drive economic, and therefore stock market, value. (Location 670)

earn huge spreads on their capital, have little need to invest and spew out cash. Just because they are not growing it does not mean that they have little value. On the contrary, these businesses are like annuities: they may not show much growth but they still deliver a little changed level of cash income, year in, year out. (Location 672)

To reiterate, businesses that grow, earn low rates of return on their asset base and produce little or no free cash are intrinsically close to worthless as investments. Businesses that are stable and which earn a modest spread over and above their opportunity cost of capital are likely to have modest values. Businesses that grow, have high returns on their capital and produce an abundance of free cash are highly (Location 678)

the return on capital (or the net assets employed in the business). This measures how well the company is managing its balance sheet. (Location 724)

To produce the growth, the more capital-intensive Sanford must add to its capital base by 10% p.a. whereas 5% p.a. suffices for the less capital-intensive (Location 735)

The shape I covet most has a scalable offering, which is tough for rivals to compete with, plus a low level of cost (especially fixed cost). (Location 844)

A good business is one that takes capital but where the return it generates on that capital is highly satisfactory and well above the company’s cost of capital. (Location 850)

Enduring competitive advantage, based on quality of ingredients, response time, reputation and the harnessing of sophisticated ordering technology. You get the same offering whichever store you buy from. Roll-out potential – more than an eight-fold increase in UK store numbers over 20 years. Yet there is still significant growth potential in the UK and Ireland, towards 1,200 stores. Stores’ capital investment is borne by the franchisees. The parent company needs capital only for infrastructure. The parent company takes approximately 40% of stores’ sales through royalties, franchise fees, sale of ingredients, property leasing and IT systems. There are margin benefits from economies of scale. There is strong cash generation allowing a progressive dividend policy and periodic returns of capital to shareholders. (Location 871)

Business Perspective Investors tread the middle ground, seeking to fence off as much risk as possible whilst still making decent returns. They define risk as business risk, not risk associated with stock market price fluctuations that bear little correlation to the economic realities of the business in question. They believe that ultimately economic value and share prices converge; they just don’t know when it will happen. Business Perspective Investors look for above average returns predictable to a high degree of certainty and carrying the lowest possible risk of permanent capital loss. (Location 1036)

Relatively capital-light businesses will still be able to generate free cash for an extended period because they have less need for maintenance capital expenditure. But capital-intensive businesses remain hungry – and the prognosis for them at this point is bleak. (Location 1045)

capital employed = fixed assets + net working capital + cash (Location 1130)

The return is operating profit plus any interest received on cash, the latter effectively being shareholder equity that has been placed on deposit at the bank. (Location 1136)

For example, if a company takes on new debt at 5% and invests it for a return of only 8%, it will nonetheless generate more in extra profit than it will pay in extra interest. (Location 1139)

I have come to the conclusion that return on equity is like the rifle to the scattergun that is return on capital employed. (Location 1148)

ROE is so much more specific because it concentrates exclusively on how good, or otherwise, management is at compounding your equity investment. (Location 1149)

This is then divided by the book value of equity on the balance sheet (after adding back any written-off or amortised goodwill or acquired intangible assets, and deducting any pure accounting items such as a revaluation reserve). (Location 1153)

the sales-to-equity ratio (Location 1160)

the earnings margin. (Location 1160)

There are only two effective ways to increase the earnings margin: increase operating profit for a given level of sales or reduce the tax charge. (Location 1168)

More operating profit comes from tight control of overheads. Reductions in the tax charge can be extrinsic, such as reduced rates of business taxation, or intrinsic, like better treasury management and tax planning. (Location 1170)

The sales-to-equity ratio measures how efficiently the company and its management are using the capital invested by its owners to generate higher revenues. In general, less capital tied up in assets for any given level of profit translates into less business risk and greater free cash flow. (Location 1172)

The latest snapshot of how ROE is evolving comes from calculating the marginal return on the most recent slug of investment in the company. This is accomplished by dividing the incremental change in earnings by the incremental increase in equity. This is shown in the formula below, where 1 and 2 refer to consecutive years: (Location 1182)

apparent. Marginal returns rise and fall long before the average and, as such, act like a magnet dragging the average up or down. They are therefore a powerful lead indicator for both the future upside and downside potential. Treated with care, they can be an early warning sign of problems lying ahead. (Location 1202)

The marginal returns were moving sharply in the wrong direction and this could be seen more than six months before the profit warning. (Location 1205)

This introduces a smoothing factor into the analysis and may give a better representation of the trend, particularly in businesses where the immediate returns can be volatile. (Location 1209)

Used properly, the concept of profitability of capital can help you to avoid the traps laid by companies pursuing growth for its own sake. It also explains why a narrow focus on growth alone may lead to a weak analysis. (Location 1212)

wrestling with the trade-off between growth and profitability and how, alone or in combination, each can create value. The resolution came courtesy of the concept of economic profit. That is the subject of this chapter. (Location 1225)

Economic profit is defined as the profit earned by an enterprise over and above all its costs, both operational and financial, including an imputed cost to equity. It has been a part of economic theory for more than 100 years. (Location 1228)

On the other hand, if the focus had been entirely on governing, once just a few territories had been acquired and horizontal expansion had stopped, potentially productive new territories would have been overlooked. The art of developing both an extensive and a productive empire was to balance growth with productivity. As it is with empires, so it is with companies. (Location 1243)

Gross means equity shareholders’ funds, plus goodwill written-off or amortised, minus revaluation reserves. (Location 1251)

Subtract from that return the imputed ‘cost’ of using that equity capital in the business. This is equal to the return an investor might expect on the next best alternative use of his capital if it was invested in a security of the same risk class. I generally use 8% on equity, this being my 10% required hurdle rate of return on equity, less the standard corporation tax rate of 20%. (Location 1255)

Improve the rate of return on the existing base of capital. (Location 1387)

Invest at returns that exceed the cost of capital. (Location 1389)

Good managers will know when they have come to the end of their stock of high returning projects; they start to return surplus capital to owners. (Location 1390)

Get rid of underperforming assets. (Location 1393)

Adopt a more tax-efficient capital structure. (Location 1396)

economic profit is unlikely to continue to grow indefinitely. There is a finite time period over which investors can expect management to initiate new, value-adding projects, either internally through organic means, or externally via acquisitions. (Location 1398)

economic profit down is either new entrants into a market, attracted by the size of returns being generated by existing players, or substitute products that reconfigure the product proposition. (Location 1401)

technical edge prone to be eroded by a maverick competitor who couldn’t care less about immediate returns on his capital. (Location 1405)

The main takeaway point is that mastering economic profit and its relationship with market value-added keeps you from allocating capital to investments that have neither the hope nor the prospect of providing you with a decent return on your capital. (Location 1464)

The theoretical justification for earnings as a valuation tool is that, over time, earnings translate into cash. It was John Burr Williams in The Theory of Investment Value who first championed the proposition that the net present value of the stream of expected future cash flows determines the intrinsic value of an investment. (Location 1487)

the investor gives up a scarce resource – cash. In return, he expects cash back in the future; in dividends and/or capital appreciation that can be crystallised into cash. The value of any investment is the stream of future cash flows that an investor can expect, discounted back to a lower net present value in recognition of the fact that cash received today is worth more than cash received tomorrow. “Laying out cash now to get a whole lot more cash later on,” as Warren Buffett would put it. (Location 1490)

“If we could see the future of every business perfectly, it wouldn’t make any difference to us whether the money came from running street cars or selling software because all of the cash that came out – which is all we are measuring – between now and Judgement Day would spend the same to us … Once it becomes distributable, all cash is the same.” (Location 1511)

That’s fine for expenses that can be directly identified with the transaction concerned, such as raw materials or labour. But what about indirect expenses such as the establishment overhead incurred in running the business as a whole? What about recovery of manufacturing overhead or depreciation? What about apportionment of R&D expenditure? That’s where the accrual principle comes in to spread costs over the period in which economic benefit is being derived from what has already been spent. (Location 1518)

Working capital consists of short-lived forms of asset, such as stocks and work-in-progress, debtors and creditors. The formula is: net working capital = stocks + debtors – creditors (Location 1524)

Debtors (also known as receivables) represent credit granted to the customers of the business – in other words money owed to the company that has yet to be collected. (Location 1530)

Only when the customer pays up does the amount come out of the debtor ledger and go into the cash balance. Until the customer pays, the profit has been recognised but the cash has yet to be received. (Location 1533)

The problems arise when obsolescence sets in, leaving unsold inventory on the shelves, or customers fail to pay their debts. Converting these stocks and debtors into cash is then fraught and usually calls for write-downs or write-offs. In the process, cash is sacrificed. (Location 1536)

to go for growth by granting more favourable terms of trade to their customers, i.e. allowing them a longer time to pay. Tell-tale signs of this are systematic increases in the ratio of working capital to sales (in other words, how much working capital is supporting each £1 of revenues) and lengthening trade debtor days. (Location 1538)

The problem here is the leeway given to management to determine both the mechanics of how this charge is made and the estimate of residual value that the capital asset will have at the end of its useful life. Such decisions have an impact on reported profits. (Location 1552)

Capitalised expenditure might be assets under construction, e.g. new buildings, or R&D expenditure where the economic benefits are expected to accrue in future years, e.g. software development or bringing a new drug to market. (Location 1576)

the assets under construction will be transferred to tangible fixed assets once the building programme is completed. (Location 1578)

Management can choose to write off R&D as incurred (the most prudent way), (Location 1579)

But what if the benefits don’t accrue as expected or there are performance-related problems? The cash has been spent. (Location 1581)

Written down fixed assets reduce the depreciation charge to the income statement over the remaining life of the acquired assets. Stocks (Location 1589)

The excess over net book value paid by a company when acquiring the business of another is termed (accounting) goodwill. (Location 1601)

mid-2000s, it was capitalised and amortised through the income statement over a maximum of 20 years. Nowadays, it remains on the books as an intangible asset unless an impairment test shows that there has been a diminution in its value, in which case it is written-off. (Location 1603)

The figure does not record what is actually received or paid – this appears in the cash flow statement. Similarly, the tax charge in the income statement is that accrued during the accounting period: that shown in the cash flow statement is what has actually been paid. (Location 1617)

Any business reliant upon significant productive fixed assets always has an attendant requirement to invest cash in them just to remain competitive in terms of unit sales. Therefore, to rely on a figure that is stated before a requirement just to stay in business is nonsense. (Location 1639)

world likewise prefers to show its operational cash flow as a key performance indicator – particularly when measured against operating profit. (Location 1642)

Operational cash flow is operating profit plus non-cash trading items, such as depreciation and amortisation, plus or minus working capital movements. (Location 1643)

My preference – and indeed that of most serious observers without either an axe to grind or a favourable investment case to dress up – is to use free cash flow. This is defined as follows: free cash flow = operational cash flow ± interest received or paid – cash taxes – net capex (Location 1646)

Maintenance capex is that necessary to replace worn-out fixed assets, which must be maintained to keep the existing operations in good order. (Location 1652)

Usually, I think nearly all capex is required to maintain the company’s competitive position. Where I am prepared to concede possible exceptions to this is in cases such as JD Wetherspoon opening new pubs or Lavendon Group investing in additional plant to hire out. (Location 1655)

mini-conglomerates who elevated the manufacture of apparent earnings growth through acquisitions into an art form. (Location 1661)

‘no company generating plenty of cash ever goes bust, which cannot be said for companies generating plenty of profit’. (Location 1662)

Thereafter it set about consolidating the UK vehicle parts aftermarket with a vengeance. This resulted in a plethora of acquisitions and a rapid expansion of turnover and profits as the new subsidiaries were digested. Between 1996 and 1998, the already frenetic pace of acquisition activity shifted up a gear. (Location 1666)

However, when compared with cash flow, this earnings performance begged some serious questions. Operational cash flow had fallen materially short of operating profits in five of those six years. Set against aggregate reported earnings of £45.4m, Finelist generated only £12.3m of free cash, (Location 1671)

Management argued the need to invest in fixed and working capital in under-invested acquired subsidiaries. (Location 1769)

For example, in 1997 over £9.8m of fair value adjustments were made, reducing the carrying value of the assets acquired by almost 30%. Asset write-downs or provisioning for liabilities increased the goodwill element relating to the acquisition which, of course, depressed shareholders’ funds. (Location 1773)

A higher working capital requirement was the main reason for Finelist’s poor operational cash flow; less material was a low depreciation charge in relation to the operating flows of the business. (Location 1775)

Acquisitions spending between 1995 and 1998 totalled £231.2m. Related equity issues raised £89.8m of this, net of expenses. (Location 1779)

Finelist went from net cash of £1.2m as at end June 1994 to net borrowings of £156.9m as at end June 1998, representing gearing of 228%. (Location 1781)

Net working capital to sales had been consistently escalating as the stock turn fell, despite Finelist appearing to take longer credit from suppliers. Shareholders’ funds were substantially reduced by £129.7m of goodwill set off against reserves. Adding back this sum, gross shareholders’ funds stood at £247m. Of this, retained profits constituted only 34%. (Location 1784)

Taking the average figures, adjusted for the goodwill written-off, ROCE fell from 45.4% in 1994 to 12% in 1998, whilst the more important ROE measure fell from 30.4% to 10.4%. Earnings in 1998 were £19.7m, an excess of £18.3m over 1994. (Location 1788)

Firstly, the only earnings that count are those that get reflected in cash, either now or in the future. Secondly, the value of any investment is governed by the stream of future free cash flows that an investor can expect, discounted back to present value in recognition of the fact that cash received today is worth more than cash received tomorrow. (Location 1810)

Thirdly, by focusing on the cash flow statement, rather than the profit and loss account, you can avoid the dangers of investing in companies that are long on promise and short on delivery. (Location 1813)

buy only when there is an appropriate margin of safety between the price you pay and the value you believe you are getting. (Location 1823)

Try not to make calls that are anything other than blindingly obvious. Unless it is a no-brainer, you are best advised to stay away. It does take time for this lesson to really sink in. When it does, your record should go from good to superb. (Location 1824)

subtle. There is a broad spectrum across which the predictability of various business models is cast. Some are predictable to a high degree of certainty – those are the ones that Business Perspective Investors prize highly – whilst others are completely the opposite and suitable only for speculators or momentum investors. (Location 1826)

how does it make its money and what external factors influence its fortunes? Ask yourself how is the product used? Where does the demand come from and how reliable is that demand? Is the company providing a necessary and must-have product? (Location 1830)

“Warren focuses on the predictability of future earnings; and he believes that without some predictability of future earnings, any calculation of a future value is mere speculation and speculation is an invitation to folly. He will make long-term investments only in businesses whose future earnings are predictable to a high degree of certainty. The certainty of future earnings removes the element of risk from the equation and allows for a sound determination of a business’s future value.” (Location 1966)

rate, say 5% compound annual growth, exceeded over a period of five years and the rate of growth to be accelerating or, as a minimum requirement, static. Where possible, this analysis can then be broken down into sales per product or sales by geographic area. (Location 2011)

net working capital (NWC) = stocks + trade debtors – trade creditors (Location 2017)

gross equity = shareholders’ funds + goodwill written-off or amortised – revaluations (Location 2019)

Table 8.1 shows that the tangible fixed asset turn has been range-bound over the analysis period at 6.4 to 7.4, with the exception of a spike upwards to 8.4 in 2008. The need for a higher level of working capital to support sales is also evident. Stock turn has fallen markedly in recent years from 3.3 to 2.3, with additional stock of new products being carried at a time when sales growth experienced a hiatus. (Location 2173)

the ratio of net working capital to sales has gone up from 16.9% to 25.5% over ten years. This need for additional working capital to support sales ties up more cash on the balance sheet. Sales generated per £1 of equity invested have fallen from 278p to 213p over this period. (Location 2178)

Competition, i.e. the intensity of rivalry that exists in the market place. Barriers to entry in the shape of know-how, intellectual property rights, skills, scale economies and absolute cost advantages. The availability of direct and indirect substitutes. The utility delivered by the products or services to their target market, thus conferring pricing power. The ability to deliver that utility at an economic cost in relation to its input factors, namely materials, labour, distribution etc. Control of central overheads and financial costs such as labour, property and energy costs, the rate of interest and the level of debt. (Location 2184)

There is often a trade-off between increasing profit margins and generating higher unit sales. The determinant is how sensitive volume demand is in relation to price changes, i.e. price elasticity. A high profit margin is good because it requires less investment in fixed, current and human assets, which, in turn, reduces business risk. (Location 2209)

The former was associated with the disposal of a non-core subsidiary, Driza-Bone, in Australia, and the latter with the small dip in underlying flooring sales. Over the last five years, gross margins have been relatively stable following the decline witnessed from 2006-11. Conversely, operating margins have improved from 13.3% in 2006 to 19.7% in 2015. The reason is tight control of overheads. (Location 2431)

Expressed as a percentage of turnover, sales and distribution costs have fallen from 23% to 17.9% and administration expenses from 9.3% to 4.1%. (Location 2434)

I have already said that the strongest franchises with the greatest barriers to entry are normally reliant upon an invisible asset like proprietary technology, skill sets or owning a piece of their customers’ minds. (Location 2449)

Companies have a number of ways of financing their operations. The best do it internally via retained earnings, which are then reinvested at attractive rates of return. The worst do it externally by over-borrowing and/or continually passing the hat around with new share issues. (Location 2455)

current ratio = current assets ÷ current liabilities quick ratio = (current assets - stocks) ÷ current liabilities gearing = net debt ÷ net equity (shareholders’ funds) (Location 2462)

The current ratio has strengthened over recent years, largely as a result of the increase in cash balances. The quick ratio strips out stocks on the basis that these might not be readily saleable. In a theoretical liquidation, Halstead would comfortably be able to settle up with all its debtors and creditors, leaving its cash and other assets intact. This is evidenced by the quick ratio being well in excess of unity. The large difference between the current and quick ratios in this instance is indicative of the business carrying large levels of stock. (Location 2654)

Not least is to compare the growth rate in free cash flow with that of earnings over a prolonged period. Another is the make-up of gross cash flow. Is it mainly operating profit (the best outcome), or does it rely heavily on add-backs such as depreciation or amortisation? (Location 2677)

They compute how many times the gross interest payable is covered by operating profit plus gross interest receivable. But since bills are paid out of cash, a much better computation is to work with the cash flow statement and see how many times interest paid is covered by operational cash flow plus interest received. (Location 2689)

capital. This increases risk of stock not being sold, debts not being collected or obsolescence of current assets. Shareholders cannot spend working capital, only cash. Stock valuation in particular can be fudged, as can debtor balances to a lesser extent. A comparison of operating cash flow, defined as gross cash flow ± working capital changes, with operating profit is useful in this regard. (Location 2696)

An interesting aside is to evaluate whether the sustainable free cash flow is enough to service the debt burden that would arise on borrowing to buy the business in its entirety. This is the first port of call for private equity buyers. (Location 2702)

Cash interest cover is enormous; hardly surprising given that the group operates with large cash balances and rarely uses bank facilities. There is no true debt, only the £0.2m of preference shares (which IFRS oddly treats as debt rather than permanent capital). Likewise cash taxes are comparable to the charges shown in the income statement, so no worries there. (Location 2884)

If there is some truth in that, it is because valuation is more a matter of judgement, i.e. balancing the consideration of many factors, rather than the unthinking application of strict mathematical formulae. (Location 2946)

Buffett learned this from his mentor, Ben Graham, whose classes were all about valuing companies. He would present his students with figures about Companies A and B and ask them to perform an evaluation. Sometimes, at the end of the exercise, they would be told that A and B were actually the same company at different points in its history. He was attempting to educate the mind to think about which variables are relevant or perhaps dominant. (Location 2951)

are. If they are not predictable, close the book and move on. But if you can identify the dominant variables, you can then move onto the science part. That involves formulating a financial model to reflect how the business operates and makes its money. Such models cannot be relied upon to provide an exact valuation though. There are no absolutes in valuation; you are looking for the range of values that you think the business might be worth. (Location 2955)

A financial investor will view the company as a standalone entity, basing judgement on the risk-adjusted financial returns likely to be secured from an investment in the company. The return must compare favourably with opportunities elsewhere, e.g. property, bonds or other companies. One financial investor has no theoretical advantage over any other financial investor and, in receipt of the same information and under identical assumptions, ought to arrive at much the same valuation as any of the peer group. (Location 2969)

Conversely, a strategic investor might be able to secure additional value over and above that available to the financial investor, even with only partial ownership of the company. These extra gains derive from synergies between what is already owned and the new acquisition. Examples include economies of scale or access to new products and markets. (Location 2977)

At the company level, this translates into the market capitalisation divided by earnings, i.e. profit after tax and any minority interests and preference dividends. It is usual to take prospective EPS or earnings for this calculation, rather than historic. (Location 2999)

The earnings yield is the reciprocal of the PER expressed as a percentage. Thus a PER of 12.5 translates into an earnings yield of 8%. It was only in the 1960s that the PER (an American concept) assumed superiority over the traditional earnings yield. (Location 3049)

The earnings yield shows the initial rate of return you can expect from the earnings upon which you have a claim, expressed as a percentage of the price you have paid. If you adopt Warren Buffett’s view that equities can be looked upon as a type of bond, then the earnings yield becomes the equivalent of the bond’s coupon. The exception is that the yield is usually fixed in the case of a bond but is variable (Location 3054)

is that it is a one-dimensional number, not obviously related to any other accepted measure of value. It says nothing about the likely future growth rate of earnings, or whether they are accelerating or decelerating. Nor does it say whether one company with an identical rate of earnings growth to another is able to achieve that growth with the same level of investment. Lastly, it is indifferent to the opportunity cost of capital, i.e. what return is available from an alternative investment with the same risk-reward profile. (Location 3065)

Also, by only looking at the PEG one year out, you are capturing but a small portion of the earning power of companies, which, after all, are set up to trade indefinitely. (Location 3127)

Price to cash flow (PCF) is not dissimilar to the PER. PCF is the company’s market capitalisation divided by its cash flow. (Location 3153)

The return is simply the earnings of the business after all taxes, interest, minority interests and preference dividends have been paid for the most recent financial period. The average of the opening and closing gross equity is what this return has been achieved on. (Location 3177)

To be sustainable, the franchise must be capable of further expansion to achieve rates of return comparable to those achieved in the past. (Location 3181)

Also, the franchise must not be close to saturation maturity or currently benefiting from exceptional pricing opportunities that might close. (Location 3182)

the end of year five, we have an earnings expectation for the following year (2021) of £61.2m. Now comes the familiar problem: how to capitalise this at an appropriate multiple. (Location 3249)

But fortunately there is a short cut that you can employ. Another beauty of using a 10% discount factor is this: (Location 3454)

In an ideal situation you want 100% of the present market capitalisation to be represented by the existing business meaning that you are getting the prospect of the forward plan thrown in for free. (Location 3458)

“A lot of great fortunes in this world have been made by owning a single wonderful business. If you understand the business, you don’t need to own very many of them.” (Location 3523)

Never forget that money paid out attracts the interest of the taxman, whereas when left in the company, it compounds up safe from his reach. (Location 3577)

Reinvestment opportunities are where American companies with a large domestic market have such an advantage over British companies. (Location 3578)

dividend income does form an integral part of the total return of an investment; the other component being capital growth. Dividends are important for more than income generation, though. They provide a useful check during the process of assessing a company as an investment prospect that management is being rational about allocating capital. (Location 3582)

without the company generating sufficient free cash to cover its reinvestment requirements and still having some cash left over at the end to reward its shareholders. (Location 3585)

progressive dividend policy, sometimes accompanied by periodic returns of surplus capital (via share buy-backs or special dividends) is an excellent sign that management has the owner’s eye. Paying dividends, rather than hoarding cash more in hope than expectation, is a very good management trait. (Location 3586)

Also, over the long-term, dividend-paying shares appear to perform better than their non-paying counterparts and deliver stronger relative returns in difficult economic times. (Location 3592)

Only buy when you appear to be receiving more in value than you are being asked to pay in price. Concentrate your investments in companies you know well. Buy and hold for the long-term, letting the success of the investment be judged by how the company performs, not by its share price. Only sell when something looks to have gone wrong; never solely to crystallise a profit. And lastly, prefer highly profitable reinvestment to dividends, but dividends to the hoarding of cash for no apparent good reason. (Location 3596)

Having made the investment, allow time and compounding to work their magic. Resist the temptation to sell a holding unless there is a very good specific reason. Avoid the temptation to sell solely to crystallise a profit. Run your profits and cut your losses. By so doing you will be well on the road to investment enlightenment and success. (Location 3629)