Introducing Tom Yeung Benefit and protection
The Moonshot Investor leaves next week.
You read correctly.
But it’s not because I was fired…
It’s not because of the markets either; my portfolio of choice managed to outperform the Nasdaq composite by a wide margin of 11% since January…
…Instead, it’s because we’re launching Profit and Protection by Tom Yeung, a newsletter on how to make money during the good times while protecting your income during the bad times. This is a letter that will cover strategic investments in quality growth stocks at reasonable prices, and yours truly will make the choices and decisions.
Click here to register.
Ordinary Moon shot readers will have already seen some of these changes.
Mid-cap value stocks like Martin channel partners (NASDAQ:MMLP) and Information Science Volt (NYSEAMERICAN:VOLT) now feature prominently; unlike meme stocks such as GameStop (NYSE:EMG) or AMC Entertainment (NYSE:CMA), these cheap companies have good downside protection. And crypto coverage has declined since February, when my Moose Master strategy signaled that it was time to get out.
There will also be new additions. Quantity-based strategies will figure prominently. And there will be new names, lesser known ones XL fleet (NYSE:XL) — a business that is trading at a price below its cash value — at AT&T (NYSE:J), a household name benefiting from the consolidation of 5G network providers.
To ensure you stay up to date with these selections, sign up here to receive Profit & Protection from Tom Yeung.
How to Make Money Without Really Trying
As a former Wall Streeter, I have a confession to make:
Earning money in the stock market is easier than it looks.
Despite all the bluster from Wall Street and the talking heads of CNBC, picking winning stocks doesn’t require a PhD. or a CFA charter.
Consider Home deposit (NYSE:HD), a company easily visible to anyone driving on the freeway.
$10,000 invested in the Home Depot IPO would have turned into $60 million.
Or what about South Norfolk (NYSE:NSC), a monotonous railroad business covering much of the East Coast?
In either case, regular investors would have outperformed the market without really trying.
This is because the secret to high yields has nothing to do with insider access…
You don’t be the smartest person in the room…
And his definitively not to work on Wall Street.
Instead, companies like Home Depot and Norfolk Southern are what I call:
Perpetual slot machines.
And here’s how they work.
The Perpetual Slot Machines of the Stock Exchange
Perpetual ticket machines are one of the less understood the concepts of Wall Street.
This is because the term is often confused with compound interest — the “eighth wonder of the world”, as some think Albert Einstein said.
Instead, the Perpetual Money Machine is a combination of:
- high cash yields; and
- The ability to reinvest returns over long periods of time.
Together, these two can help investors achieve 1,000x returns with virtually no effort.
Here’s why it works.
Imagine one day, a traveling salesman sells us a golden egg hen every day.
We are obviously skeptical at first because we are seasoned investors. Who ever heard of a goose that produces solid gold?
Yet the next day we find that the hen has indeed laid a golden egg.
And the next day, another the golden egg appears…
And so on…and so on.
Obviously, we’re smart enough to avoid cutting the goose out of greed.
So here’s the trick — the secret that makes the perpetual slot machine work.
Instead of spending those golden eggs or making a golden omelet, what if we went back to the traveling salesman and traded an egg for another goose?
Suddenly we produce of them golden eggs every day. It’s twice as good as before!
But why stop there? The next day we will bring the two eggs back to the seller and we will buy another two geese.
Therefore, we have four eggs a day!
So eight! Sixteen! Thirty two!
You had the idea. As long as the seller has more geese to sell, you end up with virtually unlimited growth.
The perpetual slot machine in action
Surprisingly, high yielding companies have the same magical ability to produce golden eggs to buy After golden geese.
Consider Starbucks (NASDAQ:SBUX), a business that most people associate with fancy malls and overpriced lattes.
You imagine the secret to their incredible stock market success was phenomenal marketing for decent tasting coffee.
But that’s not all. If it did, other restaurant chains would grow just as quickly.
But it turns out that another secret to Starbucks’ success is its ability to generate high internal returns (i.e. lay golden eggs).
Each new store only costs Starbucks about $250,000 to build. Forgoing the need for a dedicated kitchen means each Starbucks location has a payback period of around 1.5 years, more than twice as fast as a Chipotle or McDonald’s.
And the best part? Once Starbucks recoups its investment, these profits can be used to build another new coffee…and another…and another.
It’s like using the goose’s golden eggs to buy more geese.
In fact, even after deducting marketing and overhead costs, Starbucks generates an average of 20% return on invested capital (ROIC). Removing a 6% cost of capital means Starbucks can double in size every five years without financial support.
Meanwhile, low-performing companies have no such luxury. Companies like Dard Restaurants (NYSE:DRI) – the owner of Olive Garden – only earn a 10% return on investment. Once the cost of capital of 6% has been deducted, it would be necessary eighteen years for the company to achieve the same growth.
All the difference!
How makers do more
What about Home Depot?
Unsurprisingly, it turns out that DIY hardware has an incredibly high level 40% ROIC.
This creates a virtuous circle. The high returns are funneled into building more profitable stores and making the business a perpetual growing machine.
Buy at the right price
Investments in Perpetual ticket machineshowever, come with four caveats:
First, investors need to buy at the right price. If an investor pays double the fundamental value of Starbucks, it would take SBUX five years to “grow” in that valuation. This waiting period reduces potential returns and reduces the attractiveness of a security.
Second, the company must be able to reinvest at the same rates. If Starbucks can continue to double every five years, investors will benefit. But once it saturates the global market with cafes on every corner, no amount of excess cash flow will help the business grow further.
Third, investors must be patient. Even if the fundamental value of a company increases by 20% per year, its share price can fluctuate wildly between undervaluation and overvaluation.
And finally, there is the industry risk. High ROIC companies can easily be disrupted by technological or societal changes. Business history is littered with once mighty companies like IBM, Xerox and Kodak that found themselves in footnotes.
But if you find a perpetual ticket machine that passes all four checks, you’ll know it.
First steps with the perpetual slot machine
If you think that sounds like a lot of information, you’re not alone.
Whole volumes of books are written on the subject of financial returns…
Higher level courses are taught on the ROIC and its cousin, the CFROI…
Even most Wall Street pros can go years without understanding how high internal returns drive long-term value.
So, to help you get started, here is a list of promising companies with growth, momentum, and high ROI.
Many of these companies fly under the radar. BlueLinx (NYSE:BXC) is a distributor of industrial construction products, while NRG Energy (NYSE:NRG) is a power generation company. It’s not exactly your Cathie Wood brand of high-growth tech stocks.
But this type of investment works. BXC has grown 824% over the past five years, while NRG has gained 172%.
Meanwhile, Mrs. Wood ARKK Invest (NYSEARC:ARKK) only managed a 56% return.
Now there will be still be hyper-growth investment opportunities. Companies like Metal desk (NYSE:DM) and Matterport (NASDAQ:MTTR) are state of the art. And smart investments in promising biotechnology can turn tiny wallets into gargantuan ones.
But for those looking to bolster their core portfolio with long-term holdings, it’s hard to beat a group of companies with sustainably high yields bought at reasonable prices.
PS If you liked what you saw in this email, be sure click here to continue to receive emails from Tom Once Benefit and Protection of Tom Yeung launches next week.
As of the date of publication, Tom Yeung had (neither directly nor indirectly) any position in the securities mentioned in this article.
Tom Yeung, CFA, is a Registered Investment Advisor on a mission to simplify the world of investing.