The Quality Series · part 3 of 13
Why does linearity matter? Because it is the first link in a chain. A great business and a great investment are not the same thing, and the journey from one to the other has five links. I think about them in this order.
Linearity. A world-class business shows it in its accounts: revenue, earnings and free cash flow per share rising steadily, not in fits and starts.
Predictability. That steadiness is what lets me see a few years ahead with some confidence.
Quality of cash flow. Growth that is predictable and sustained over many years gives the cash flow quality — cash that can be counted on, rather than cash that happened to arrive.
The premium. The market notices, and pays a higher multiple for it (the price as a multiple of the cash the business produces). That is why such businesses are seldom cheap.
The price. So the last link is the only one I control. Bought at fair value, the business does the work. Bought during a passing setback, when the market prices a temporary problem as if it were permanent, I get the compounding and the rerating as well.
Two of my published calls show the two endings. Mastercard, written up at a fair price in September 2016: ten years later its multiple had barely increased, and the business did almost all of the work — a compounded return of about 20% a year to September 2026 with dividends included, enough to turn $1 million into about $6 million, against about 15% a year for the S&P 500 on the same basis. Apple, written up during a setback later that same month: its multiple roughly tripled, so the business and the repricing shared the return about equally — about 29% a year on the same basis, turning $1 million into about $12.5 million.
Both were excellent businesses when I wrote about them. The difference was the price on the way in, and that is the part I control.
The five links from a world-class business to a world-class investment: linearity, predictability, quality of cash flow, the premium — and the price, the only one I control.
Next: where a return actually comes from — there are only two places.
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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