I recently came across this interview by famous value investor Donald Yacktman with Gurufocus here. Just wanted to note down some learnings from the interview.
Company Analysis Process
- Look at the cash flows of a company. Two components
- Payout through dividends and net share repurchases
- Return on retained earnings (this is the wildcard)
- What a company does with its cash in the past is a much better predictor of what they’re going to do in the future than what they say.
- Really understand the business model — most of the time the good businesses will make the managers look like stars, rather than the other way around.
What is Considered a High Quality Company
- High Return-On-Asset
- Low capital intensity and low cyclicality (e.g. Coke, P&G)
- Low capital intensity + Low cyclicality: Consumer Staples
- Low capital intensity + High cyclicality: Media
- High capital intensity + Low cyclicality: Utilities
- High capital intensity + High cyclicality: Capital Goods (e.g. machinery)
- Fairly stable operating results in good and challenging economic environments
- Company sells a disposable product or a recurring service
- Large market share
- Prefer companies that grow faster than the S&P and can pay out 80-90% of their earnings
- Annual high single digit or low double-digit forward rate of return
- Forward rate of return = Free cash flow yield + real growth rate + inflation rate
- Free cash flow yield = Normalized earnings * (1 – % reinvested in the business) / price of business