The Quality Series · part 2 of 13
Here is a comparison I keep coming back to.
Two companies each take their free cash flow per share from one to two over five years. Same starting point, same end point, same growth on paper.
The first gets there steadily, a little more each year. The second goes nowhere for four years — 1, 1, 1.1, 1.1 — and then leaps to two in the fifth.
On a summary sheet they are identical. To me they are entirely different businesses.
The first one I can plan around. If its cash flow has climbed steadily for ten years, I can say with reasonable confidence where it will be in three to five more, and that is the basis of every valuation I do. The second I cannot. Was the fifth year the start of something, or a good year that will not repeat? I do not know, and I do not want to pay for not knowing.
I call the first quality linearity: how close the line of cash flow per share comes to a straight line rising over time. I measure it as a simple correlation with time, ideally over ten years of half-yearly figures. A perfect straight line scores one. Around 0.9 is the level I look for, though it is a guide, not a rule.
Linearity is not the whole of predictability. But it is the part you can see in the numbers before anyone tells you a story about them.
Next: how steadiness turns into a premium, and why the premium is where the real decision begins.
The series so far
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This is my personal investing journal, written for information only. It is not investment advice or a recommendation to buy or sell any security, and it does not take account of your circumstances. I may own shares in companies I write about. Past returns are no guide to future returns.
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