A secret to long-term investing that can return 15% a year

Fsp Invest, 16 Sep. 2013

Tags: investing, long-term, return, capital efficiency, compounding, cash, cash flows, how to work out capital efficiency

When it comes to buying shares, you want to make sure that you get decent returns in the process. Otherwise it’s not worth it. One way to look at companies you are thinking of investing in is to examine how efficiently they produce cash. Read on to uncover a secret to long-term investing that can return 15% a year…

You should always remember that capitalism is about capital - how much you earn and how much you keep, Dr Steve Sjuggerud and Brett Eversole explain in Daily Wealth

So you should judge companies primarily by how efficiently they produce cash.

There is a way that you can find the safest, highest-quality companies around. You need to look for an important measure: ‘Capital efficiency.’

Measuring capital efficiency is easy

All you do is figure out what a company earns on a gross-profit basis. Then, you compare that to the amount of capital that's shareholders receive back each year in the form of cash dividends or net share buybacks.

If the company earns R1,000 and distributes R800 to shareholders, that company has a capital efficiency of 80%. These cash flows allow you to rapidly compound your gains by reinvesting the dividends.

But even if you find a great capital-efficient companies, you still have to pay a fair price for it. But when bought right, they produce serious gains…

Keep in mind… you can't ignore the basics of valuation. If you pay way too much for these businesses, your returns will disappoint.

But highly capital-efficient companies tend to produce annual compound returns of about 15% a year. Few investors make this much in their own portfolios, no matter what strategy they claim to be following.

By buying below 10 times cash profits is the key to making money in these kinds of companies. And over the long run, owning capital-efficient companies is another safe way to compound your gains through any market cycle.

So there you have it, a secret to long-term investing that can return 15% a year.

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