The Quality Series · part 4 of 13
The return from owning a share comes from the growth in free cash flow per share, from a change in the multiple the market is willing to pay for that cash flow, or from a combination of the two.
That is all. Everything else — the narrative, the sector, the macro story — matters only through one of those two.
Mastercard shows the split cleanly. Over the ten years after I wrote it up in September 2016, its free cash flow per share rose roughly fivefold. Its price-to-free-cash-flow multiple barely increased. Almost the entire return (every $1 million invested in September 2016 had become about $5.8 million ten years later, about 19% a year before dividends) came from the business itself.
This is why I buy the way I do. I want the compounding alone to do the work, even if the multiple never moves. And because I try not to overpay at the start, there is less room for the multiple to fall. The upside comes from the business. The mitigation of downside risk, what Benjamin Graham and Buffett after him called the margin of safety, comes from the entry price.
It also explains why I pay so little attention to forecasts of where the market will be next year. Next year’s multiple is a mood. Five years of linear, sustained cash flow growth in a business I understand is something I can project with confidence.
Mastercard, cash flow per share up about five times against a multiple up about a sixth, 2016–2026.
Mastercard, 2015–2025: the share price followed free cash flow per share. When it ran ahead in 2020 (to about 55 times free cash flow, against a ten-year median of about 35 times), it then went nowhere for two years while the cash flow caught up.
Next: the one quality I look for before almost any other — and the name Buffett gave it.
The series so far
- Part 1: The whole idea, in one line
- Part 2: Same five years, very different businesses
- Part 3: From great business to great investment
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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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