The Quality Series · part 8 of 13
Free cash flow per share can compound in three ways.
The first is to grow the cash flow itself. This is the classic compounder — a durable moat, high returns on capital, real pricing power — allowing it to compound earnings and cash flow per share at an extraordinary rate, today and far into the future. Apple, Mastercard and Lam Research all belong here. Roughly nine in ten of the businesses in my universe fall into this category.
Intuit’s free cash flow per share, fiscal 2010–2026.
The second is to shrink the share count — the share cannibal. A good business at a modest price that uses nearly all its cash to buy back its own stock. O’Reilly Automotive is the example I come back to. Here the modest valuation is the advantage, not the flaw: every dollar spent on the buyback retires more shares. And with fewer shares, each one that remains owns a bigger slice of the same cash, so free cash flow per share grows faster than the company’s total free cash flow. If the company’s free cash flow grows 5% a year and the share count falls 4% a year, free cash flow per share grows by about 9%. It works while the business is still growing, still earns a decent return, and buys back stock as a policy rather than a gesture. It stops working when growth disappears, when margins slip, or when the buybacks start being paid for with unaffordable debt.
O’Reilly’s share count falling over time.
The third is to buy the cash flow — the serial acquirer: acquiring small, mission-critical businesses in fragmented niche markets, at a steep discount to the buyer’s own multiple, and paying with cash, sometimes debt, rather than new shares. Constellation Software is the model.
Constellation Software’s free cash flow per share, 2010–2025.
All three depend on the people allocating the capital. I want managements that think like owners and build over years, not ones making decisions to flatter the next quarter. Two allocators I admire took opposite views of their own shares. Mark Leonard at Constellation would not issue stock. Henry Singleton at Teledyne used stock as currency to buy other businesses when it was expensive, and bought it back when it was cheap. Both were right.
Next: what I will not own, and why the list is shorter than people expect.
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
- Part 4: Where stock returns actually come from
- Part 5: The secret sauce
- Part 6: Why return on capital decides it
- Part 7: A moat is the power to raise prices
Sign up below and the whole Quality Series comes to you by email, in order from part 1, Monday to Thursday.
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.
Leave a Reply