Welcome back everyone. Thanks for joining.
I have a video for you today that is quite frankly a bit
different than my typical video. In fact, this is one that I'm
debating whether or not I should release it publicly or keep it
as a Patreon exclusive. I'm not sure.
Maybe we'll figure that out. We'll see how it goes.
But either way what I want to talk about is a conversation I
had over the weekend with a long term friend of mine.
There's a a buddy of mine that I've been friends with for over
a decade and we spent some time together over the weekend and I
just caught up with them, saw how things were going and I
asked him how his investments were doing right.
I know that he likes investing in different things.
He has a four O 1K, but his big interest what he invests in is
the alternative assets. Stuff like crypto, Bitcoin,
altcoins, NFTS, all of that type of stuff, this realm of
investing that I really have nothing to do with.
I have none of these investments.
They don't interest me all that much, but I listened to his
thesis on them and I thought that was overall pretty
enlightening. It was interesting.
He went over the main core thesis of crypto the fact that
it will stabilize a lot of countries that aren't as stable,
countries like Argentina that have incredible amounts of
inflation. People want something that has
stable, you know, no inflation to anchor onto.
So there's different thesis for crypto and the technology behind
it, and he's more knowledgeable about that than I am.
But part of the conversation swung back to me where he asked,
why do you invest in stocks? Like why do you like stocks so
much? And I went on to explain why.
I not only like stocks, but I love stocks, and I think that
they are by far the best investment that you can do on
planet Earth. Beyond real estate, beyond
altcoins, beyond gold, beyond bonds.
I think stocks are the supreme pinnacle of investing, And I
explained in in a longer conversation why I thought that.
So in this video, I want to go through and go through the
examples that I gave because I saw that as we are going through
this, he thought it was fascinating.
He thought it was a different way of explaining things that he
hasn't seen before. And I want to go through some of
the examples that I did. So let's go ahead and start off
with why I love stocks, why I invest in them, why I think
they're the best we can look at every single investment.
And the way that I rate every investment is based against the
risk free rate. The risk free rate is the
treasury or the federal funds rate.
It's where you can get risk free returns.
Right now the risk free rate is around 5%.
So that is what the federal funds rate is AT and that's
around the rate of a treasury bond.
So let's say that that is the risk free rate.
Ultimately, we can right now invest at 5% or put our money in
a money market account. We can put it in a high yield
savings account and we can earn 5% risk free.
Now you can even lock in this risk free rate for the next 20
years. So this is an opportunity over
the next two decades to lock in this 5%.
When I look at investing and again this is a 20 year period.
So we'll put 20 years up here, 20 years long earning you 5%
interest every single year. This is your opportunity cost.
This is what I weigh every investment that I do.
It's against this opportunity of risk free money.
Now the reason that people look at this, and I think the reason
that so many people are drawn to this is because the
predictability of returns. You know when you invest in a
treasury and you lock it in for the next 20 years, the payout
that you get will never go up and it'll never go down.
If you buy a 20 year treasury, you're going to get the same
amount of money every single year.
So you can count on this. It's predictable, it's reliable.
It gives investors a feeling of safety, a feeling of lack of
risk taking this, and that's why it's the risk free rate.
Now, there's other things to consider.
There's inflation, obviously that eats away at some of this.
So you might have like 2 to 3% inflation.
So your real return is lower than 5%.
It's the difference between inflation and the 5%, more like
2% per year. But for the sake of simplicity
in this example, let's just pretend that there's no
inflation and you get a flat 5% return.
Now, stocks in the US Treasury have some similarities and they
have some differences. The biggest difference is that
with the US Treasury, you know what you're getting.
You can see it clear as day for the next 20 years exactly what
your return will be because it's guaranteed by the government.
It's written on the the note that you get, the bond you get
tells you how much cash flow you're going to get every single
year for the next 20 years, and it's flat.
With stocks, the big difference is it's unknown.
All you know what the stock is, the starting yield.
So we can look at the example of Apple and we can compare this to
the US Treasury. Apple right now has a starting
free cash flow yield, which is just like the starting yield of
a Treasury. But Apple has a starting yield
of 3.76 percent, 3.7. The Treasury has a starting
yield of 5%. So whether or not you buy Apple
or the US Treasury is based on these starting yields and the
opportunity cost from one to the other.
The Treasury is a little bit more predictable.
It's guaranteed. Apple's a company that faces
competition. It's a bit less predictable or
guaranteed, but Apple has the potential, like every other
stock, to grow its cash flows over time.
That is, the largest distinguishing factor is Apple
can grow its cash flows over time while the treasury can't.
So let's assume for the sake of mathematical simplicity that we
buy a stock that has a lower starting yield than the
treasury. Let's say we buy one with a 3%
starting yield. So it starts down here now with
every stock that I buy. My goal is to buy a stock that
will grow its free cash flow per share at 15% per year.
If you're a fan of the rule of 72, that's a mathematical tool
you can use to see how often a number will AA growth rate will
double if you plug in 15. That means that if something
grows at 15% per year, it'll double every 4.8 years.
So we can round up to five years.
Basically, if you have a company that's growing its free cash
flow per share at 15%, around every five years, it's going to
double its free cash flow per share.
So let's assume that I'm trying to buy a stock that will grow
its free cash flow per share at 15% per year.
And it does it perfectly. It just grows its free cash flow
per share at 15% per year. And let's also assume I buy that
stock with a starting yield of 3%.
We can map this out for the first five years, 12345 for the
first four years. This stock will earn less cash
flow than the treasury. So the interest payments on the
treasury starting at 5% will pay you more than the cash flows of
this stock for the first five years.
So right here you have opportunity cost.
You're losing money for the first four years.
Only on year five are you making more money than the treasury.
On year five you're getting a 6% yield remember because the cash
flows doubled. So what you paid for it down
here you're getting a yield of 6% on the free cash flow on your
five way out here. Now if you look at this just on
a five year timeline and you're trying to judge what was a
better investment, I I probably think the treasury is, if you
just had this isolated view of just five years, starting at 5%
and earning the first four years of excess cash flow is better
than earning less for the first four years and only earning more
for one year, that's five years out.
But that's not where this stops. Remember, this is 20 years.
We invest for 20 years, We don't invest for five years.
The Treasury's still locked in paying the same amount of
interest every single year. But a stock has the opportunity
to continue growing and this is the great thing about stocks.
This is why I love them so much because they don't grow for five
years. If you find a good company,
it'll grow for year after year after year.
Let's assume that this company grows for another 15% per year
for the next five years from Year 5 to 10, 12345 and we've
reached year 10. The yield that you're paying
today based on 10 year cash flows, the year 10 cash flows is
12%. That sounds quite a bit better.
So cash flows on year 10, you're getting a 12% yield on them and
then all of these years, year 6789 and 10, you're earning
excess cash over what you would have on your 6789 and 10 of the
Treasury. So when we're measuring this
against the risk free rate, the US Treasury, many people are
buying the treasury today trillions of dollars buying up
treasuries. Many people have so much savings
stuck in money market accounts earning 5%, especially if you
lock in a 20 year treasury, you're earning that yield, that
same payment every single year with the stock.
You're going into the unknown. You might have to pay a little
bit more. You might have a lower yield.
Starting off, you might earn less the first four years, but
if you find a good one and it grows, it's free cash flow, 15%
per year. Every year after year four it's
earning more money and every subsequent year that it grows,
it's free cash flow per share. You're earning more and more
than the previous year. This is where that incredible,
that incredible principle of compounding comes into play.
And many people underestimate this.
They're very short term focused. They want safety and short
termism. They're focused on the starting
yield of 5%. That's higher than 3%.
So they pour money into the treasuries and they forgo the
opportunity to have these incredible stocks that grow free
cash flow every year. And you might not think the
companies can do this, grow free cash flow per share 15% per
year, but I can show you many examples.
There's many companies that I know that I've done this in the
past. Let's assume that right now,
year 10, we're only halfway through this journey.
Remember, we have another 10 years to go to get through a 20
year investment horizon. Well, in this case, we know what
the Treasury's going to do. It's going to pay you the exact
same amount that it did year one.
There's no increase or decrease in cash flow.
But let's assume that this is a great stock, it's a compound
machine and it's just compounding and doing buybacks
and growing organically, doing price hikes that has a nice Moat
and monopoly and it grows another 15% per year, which
would double the free cash flow per share in another five years.
So we have year 11121314 and 15. The yield that we would get on
year fifteens free cash flow is 24%.
That seems absurd, but that is accurate.
And the years of cash flow that you're getting in excess of the
the treasury year 11121314 and 15 is obscenely high.
It's way more than you're getting when you're buying the
treasury for those years. So as you go out in the
company's growing cash flows, now this company it's it's way
more cash flows than you're getting with the treasury that
has the fixed cash flow. Now another way of stating this,
which I think is even more crazy to think about and this is
something that I think is mind blowing is if you bought the
company with a 24% yield on 15 year cash flows.
So 15 years out as a 24% yield on those cash flows.
That means that the cash flows on year 15 are enough to buy
back the entire market cap that you're paying for the company
today every four years. So this amount of cash flow
would pay back on your starting valuation of the company every
four years. Because of math is pretty
simple. If you assume we have a 25%
yield, we round up to a 25. That means that if something
cost you $100 and it produces $25.00 worth of cash flow every
year, it can buy back the entire thing in only four years.
Now if we look at this again, you might think that that's
absurd and there's no company doing this, there's no company
growing at this rate, There are many doing this.
We can again look at the example of Apple.
We have Apple here and let me go ahead and just show you some
incredible statistics about this company.
First of all, we can look at the free cash flow per share.
I'll bring it up right here In 2023, if you can see this, it
says that the free cash flow per share that Apple produced was
$6.33. Remember that number, $6.33.
Now we go to Apple's stock price.
We go back about 15 years, around that time period, maybe
around 2014 and 15. Apple is trading for around 26
dollars, $25 a share. This is when Warren Buffett was
buying it. So Apple is trading at 24 to $25
per share. Now we have 6.
Remember 6.3 is what it's producing.
Last year in free cash flow and the company, the whole company
cost $24.15 years ago 612-1824. The free cash on a per share
basis could have bought the entire company of Apple in four
years 15 years ago. Another way of illustrating this
which I think is another interesting viewpoint is we can
just look at the total free cash flow.
Apple generated last year, $100 billion of free cash flow.
We can look at the market cap if we had the market cap pulled up
here. The market cap around 2014 and
2015 was around 400 to 500 billion, meaning that the cash
flow the company produces every year.
Today, $100 billion is enough to buy the entire company in four
years 15 years ago, which would mean that it trades at a 24%
yield on 15 years cash flows. That's exactly the yield the
Apple trades at over a 15 year period.
It grew its free cash flow per share to the point where it had
a 24% yield 15 years out. Apple's an example of a company
that's done this and that's why the shareholders like Warren
Buffett have trounced the market.
They've trounced the risk free rate.
They've crushed other investors. He's made hundreds of billions
of dollars on this one investment.
Now, he didn't know perfectly, with certain clarity that would
produce 15% free cash flow growth every year.
But he knew it was going to grow really fast, much faster than
the market. He understood the opportunity
cost. Warren Buffett understands
compounding. That's why he's so biased
towards stocks. That's why he loves owning
stocks that will grow their free cash flow per year, every single
year. And Apple's not the only
example. There's many companies we can
look at in plain sight, ones that you know about that are
doing this. Look at Visa for example.
If you think Apple's just an outlier and one in a million,
and it's an extreme example of survivorship bias, we can take a
look at Visa. Everyone knows about Visa.
Everyone uses Visa. It's grown as free cash flow per
share at 25% for the past decade, 12% for the past five
years, so a little bit lower for the past five years, 18% for the
past two years, so somewhere between 12 to 17%.
That's right in line with this example.
Visa's another one. We also have MasterCard,
Mastercard's another company that has done this.
We also have Costco, Costco, everybody knows this company.
You probably have a membership there.
We can look at Costco's free cash flow per share and over the
past decade it's 17% above this example.
So if you're saying this is extreme, Costco has beat it.
The company that I've invested in for seven years has beat this
example and over the past five years it's grown at 19%.
That's really trounced this example.
So Costco is not only doing this, it's doing it at a higher
speed. And again, this isn't something
where it's it's survivorship bias or looking at only few
companies. Many of the companies that we
know and understand are doing this, we can again look at
Google. Google's a company that everyone
uses on almost a daily basis. Who doesn't have a Gmail
account? Who's not on YouTube?
You're on YouTube right now. Listening to this, Google has a
free cash flow per share growth over the past decade of 20.5%.
It would be faster than this example, a better investment
than this. If we look at Google's free cash
flow per share over the past five years, it's 27%.
It's growing at a staggering rate, and there's other examples
I can list. I can continue on.
This isn't just survivorship bias, but it's a small pool of
companies that are compounding machines.
They have the economics, the Moat, the pricing power to
continually do this. Companies like FICO and Chipotle
and the railroads and so many of them that are growing their free
cash flow around 13 to 17%. So what I try to do is I try to
look for companies that will grow their free cash flow per
share at 15%. And then the hard part is trying
to get into these great companies.
At 1/2 decent starting yield, we don't want to go too low with
the starting yield because if you get down to 2%, if you get
down to 1%, even if they grow fast, you're starting at such a
disadvantage that it takes a long time for it to surpass or
even get past the point of the risk free rate.
So you don't want to buy too expensive.
That's a price even high quality investors make as they pay too
much. I'd rather start at 4%.
If I could get 1% below the risk free rate and have it grow up
15%, then I'll be, you know, that's a way better opportunity
for me in my opinion. And I'd love to even get a
starting yield above the risk free rate.
What if you could start at 6% and have a company grow free
cash flow per share, 15% per year?
Obviously that's dramatically undervalued.
That company would be an incredible deal and in some
cases that happens. It happens infrequently, It
happens rarely, and it happens when a high quality compounding
machine gets sold off temporarily.
So there's some examples of this happening again, it's it's a
rare thing. You have to look out for it.
But I think those are the best situation where you can find a
stock that will grow and grow and grow its free cash flow per
share and it starts at a yield of around 5% where the
Treasury's at or even above it. That's an incredible deal when
you can find them. I'll give you one example of
that happening. It happened recently with
Netflix. If we look at Netflix, this is
some staggering information. I find this so, so interesting.
Netflix obviously had like a, you know, there's a lot of
people that were scared about the company.
It sold off because competition was coming at it and it went
down 70%, which that number doesn't matter if you're an
investor, don't look at how much the company sold off for or what
it used to trade for, Just look at the price it's selling at.
In 2022, Netflix was at below $200 per share.
At that share price, Netflix had a market cap of $80 billion.
That was the cost of the entire thing.
You could have bought all of Netflix, 100% of it for 80
billion. So if you're buying a share of
the company, you're buying it at an $80 billion valuation.
Now keep that number in mind. If we look at Netflix's free
cash flow in 2023, it had free cash flows of $7 billion.
So in 2022, you could have bought the the company for $80
billion and then 20/23 it had free cash flows of 7 billion, 7
/ 80 is roughly 9%. That is the yield you were
getting on this company, buying it here and having the cash
flows one year later. So investors that bought it at
the low at $80 billion valuation, we're getting a 9%
yield on 2023's year year's free cash flow.
If we look at this, it's as if you started and we can clear
this out. I'll clear this out to make it a
little bit easier to look at. Let's clear out this example
here and let's look at Netflix as the example here on what
investors were getting compared against the risk free rate
investors that were buying Netflix in 2022.
We're getting a 9% yield on 2023's cash flows.
So they had zero cash flows for the first year of their
investment. They didn't earn anything.
They had to be patient and wait one year.
But then immediately after one year, the starting yield was 9%
all the way up here and they own a company that's presumably
going to grow its free cash flow per share in the future and go
up overtime to even make the difference bigger.
Now if you had perfect clarity of the future and you had these
two choices presented in front of you, you could either invest
in the treasury with a 5% yield or you can invest in Netflix.
That's a 0% yield on year one, but then it goes to 9% year two
and after that it will grow every single year.
The choice becomes very obvious. Everyone would choose.
To invest in this thing that has a starting yield of 9% after
year one, because you're only sacrificing one year of cash
flow to instantly almost double your cash flow every subsequent
year for the next 19 years. This is obviously a much better
deal. It's like a double the better
deal, right? Triple it.
Once it became clear that Netflix can generate $7 billion
worth of cash flows, investors realized, oops, it was selling
at a 9% yield back here. That doesn't seem right.
Buy, buy, buy and they pot the stock like crazy.
It went up well over 150% in the following year.
So Netflix recovered in price because investors became aware
of this bigger picture, right? They couldn't see the future a
year ago, but investors that could have an idea of the future
or what Netflix could potentially generate in free
cash flow and they bought it. During that time period, they
were buying these cash flows at a 9% yield and that's why the
stock went up 150%. Now I realize that I'm not going
to find companies like Netflix that have that 9% starting yield
on next year's cash flows. That is super rare.
Those happen occasionally and frequently and hopefully I take
advantage of them when they happen.
But on a more common basis, what I'm trying to find are the
companies that have a higher starting free cash flow yield
close to the treasury of maybe 4 percent, 4.5% around there, as
close as I can get or even a little bit above that, also have
incredibly bright futures that are growing their free cash flow
per share at 15% per year. That will quickly surpass the
opportunity cost of the treasury.
And that's what I've been focusing on in My Portfolio.
I know I'm going to make mistakes.
Not every company I buy is going to be a winner, there's going to
be losers. But if I buy a basket of like 12
to 15 of them and hopefully most of them do pretty well and grow
their free cash flow per share 12 to 18% over time overall the
portfolio will have incredible outperformance of this
opportunity cost. It'll do really well over time.
So that is a a glimpse, I'd say a nice little overview of how I
view valuation. Now again, I want to stress just
one last time, you're looking at a lot of companies that I think
are are dangerous in their valuation.
We have companies like NVIDIA that have below a 1% starting
free cash flow yield. That's fine if they can grow
their free cash flow at an insane rate, which they're doing
right now. But just notice the difference
they have to make up to get to the point where they're at the
risk free rate. It has to grow its free cash
flow 100% to get to 2% and then another 100% to get to 4% and
then another 100% to get past it to 8%.
So you're talking about hundreds and hundreds of percentages of
free cash flow growth just to get above the risk free rate.
That's why I think companies like NVIDIA and ones that are
incredibly high-priced, they're a little bit riskier.
Those are not the ones I'm going into, the companies that I'm
buying, the companies I'm looking for.
I'm looking for that sweet spot of 3 1/2 percent, 4% and growing
quite nicely. Those are the ones that I'm
targeting. And overall, This is why I just
love stocks. There's really nothing else like
it. There's never been an asset
class that's outperformed it. It's been the best performing
asset class ever over the past 100 years.
And even real estate, other great asset classes have major
disadvantages. It's a liquid with stocks, you
can change your mind. If you make a mistake, that's
fine, just sell the company and and swap it for another one.
With real estate, you can't really do that.
You're you're putting big down payments.
You have to deal with tenants, you have to deal with managing,
managing teams. You have to deal with lawsuits
and squatters and all sorts of challenges with real estate.
With stocks, you can sit here, You can do analysis from the
comfort of your own home and you have the potential to earn
tremendous amounts of alpha and tremendous amounts of
compounding and gains if you construct a smart portfolio of
great companies that trade at reasonable valuations and grow
their cash flows quickly. So to me, stocks are the best.
I think they are the best investment hands down.
Nothing comes close. That's my thoughts.
I hope you enjoyed this little insight.
I'm sorry that's a bit different than my normal video, but I
thought it was interesting that I would share.
That's all for now. See you in the next one.