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Rate of Return and Don Yacktman's Top 15 Holdings

Micah Martin

Micah Martin

In April, Gurufocus posted a recent interview they had conducted with Donald Yacktman, a well-known investor with an extremely impressive track record — beating 99% of his peers over the last three, five, ten and fifteen-year periods. I highly recommend reading the entire interview; it is most definitely worth your time.

After reading the interview, I decided to delve just a little bit further into the answers where Mr. Yacktman discusses how he calculates the forward rate of return. Here are two select questions/answers from the above interview:

“[Question]: I have previously read some very interesting articles in which you discussed how you calculate the forward rate of return. However, I would like to ask if you could go into a bit more detail…

[Mr. Yacktman]: This number is a calculation of a normalized free cash flow yield plus real growth plus inflation. If the business is stable, this calculation is fairly straight forward. For instance, on the S&P 500 we would normalize earnings. We would then calculate what percentage of those earnings are not reinvested in the underlying businesses and are therefore free. Historically, for the S&P 500, this has been just under 50% of earnings. Currently, we expect the S&P to earn about 70 on a normalized basis, a number which is far below reported earnings due to our adjusting for record high profit margins. $70 X ½ / 1400 gives you a normalized free cash flow yield of approximately 2.5%.

The historical real growth rate of the S&P 500 is about 1.5%. Assuming an inflation rate of 2.5%, the forward rate of return on an investment in the S&P 500 is about 6.5% today (2.5% free cash flow yield plus 1.5% real growth plus 2.5% inflation). We prefer companies that have historically grown faster than the S&P 500 and can pay out 80-90% of their earnings. Today, several of our favorite companies, including Sysco, Clorox, Pepsi, and P&G meet this hurdle and trade at a discount to the market on normalized earnings. We use these types of businesses as our baseline discount rate.

Back to October of 2008, Procter & Gamble (PG) had a forward rate of return of about 9-10% while Viacom (VIA) on depressed results offered a higher free cash flow yield than our total rate of return calculation for P&G. This is not even considering growth potential for Viacom which we thought was significant from the depressed earnings level. This is an example of an easy swap that yielded huge results.

[Question]: What is the level of required return you demand for the best business today? When you normalize earnings, how do you treat and incorporate one or two years of loss a company experienced in the past?

[Mr. Yacktman]: We generally demand an annual high single-digit or low double-digit forward rate of return for a high quality business and more for one we think is lower quality. Normalizing earnings is dependent on the specifics of each company.”

Below I created a table with a rough forward rate of return for Mr. Yacktman’s 15 top holdings, but before you skip to it please read my two caveats first:

1. The table below is not “risk-adjusted.” I have not done an extensive risk analysis on each of these companies, and thus I decline to speculate as to how much risk should be factored in to each forward rate of return. That said, to help the return numbers be a little more conservative, I used the average FCF per share for the last three years in my calculations. Regardless, though, the more stable the company, the less adjustment needs to be made for risk.

(For example, P&G’s actual risk-adjusted rate of return would be much closer to the number below [11.3%] than a ConocoPhillips would be to its return figure [20%]. I want to be clear that this table is not to give a thorough, risk-adjusted rate of return for the following companies, but rather to merely give food for thought.)

2. For estimating growth I simply used conservative estimates based on past growth rates. The growth figures aren’t set in stone, and I didn’t spend hours researching estimated rates of growth, etc. Do note that the growth rates are rough estimates of real growth without inflation. They might seem lower than they should be, and that’s fine. Again, my goal isn’t to nail my growth predictions perfectly. (For all the figures I used GuruFocus’ database, sometimes using estimates due to different fiscal years for different companies.)

With those two caveats out of the way, here is a table of the forward rate of return for Mr. Yacktman’s top 15 holdings:

Company Portfolio Weight* Last Price^ FCF Per Share (3-yr avg) FCF Yield Inflation Growth Rate of Return
1 Pepsico 10.8% $67.68 $3.33 4.9% 2.5% 3.0% 10.4%
2 News Corp- A 10.4% $19.29 $1.21 6.3% 2.5% 3.5% 12.3%
3 Procter and Gamble 10.0% $62.76 $4.25 6.8% 2.5% 2.0% 11.3%
4 Microsoft Corp 6.7% $29.23 $2.90 9.9% 2.5% 3.0% 15.4%
5 Sysco Corp 5.2% $28.62 $0.76 2.7% 2.5% 2.5% 7.7%
6 Cisco Systems 4.8% $16.58 $1.70 10.3% 2.5% 0.5% 13.3%
7 Bard C R Inc 4.6% $98.55 $6.60 6.7% 2.5% 3.5% 12.7%
8 Viacom Inc-B 3.9% $47.38 $3.78 8.0% 2.5% 3.5% 14.0%
9 Coca Cola 3.5% $74.28 $3.03 4.1% 2.5% 3.0% 9.6%
10 Johnson & Johnson 3.4% $62.80 $5.05 8.0% 2.5% 1.5% 12.0%
11 US Bancorp 2.8% $29.58 $3.95 13.4% 2.5% 1.0% 16.9%
12 Pfizer Inc 2.7% $21.94 $1.86 8.5% 2.5% 1.5% 12.5%
13 ConocoPhillips 2.6% $53.81 $8.60 16.0% 2.5% 1.5% 20.0%
14 Clorox Co 2.6% $71.35 $3.69 5.2% 2.5% 3.0% 10.7%
15 Avon Products 2.1% $16.25 $0.87 5.4% 2.5% 1.5% 9.4%
- S & P 500 1,315 $35.00 2.7% 2.5% 1.5% 6.7%

*As of 3/31/2012

^At close of trading day- 6/7/2012

Two quick thoughts:

1. 9 of the 15 stocks have a three-year average FCF yield that is higher than or equal to the expected total future return of the S&P 500. Stability and sustainability of a high-quality company’s free cash flow are thus necessarily a major factor in Mr. Yacktman’s portfolio choices. In general, growth, while a factor, is not valued as highly as stable free cash flow yield in his projection of future total return.

2. I believe that Mr. Yacktman and his colleagues are in an excellent position to surpass the returns of the S&P 500 for quite some time in the future. It’s hard to imagine a long-term scenario where these strong companies with their current rates of return and sustainable free cash flow underperform the S&P 500, especially considering that every single one of them currently has a higher rate of return than the S&P 500. (Many of them were purchased at even higher rates of return late last year and earlier this year.)

Finally, if readers have methods, ideas or other advice about calculating the forward rate-of-return, please comment! I would love to hear what you have to say.

Disclosure: Long PEP, JNJ

Rating: 4.5/5 (30 votes)


Becomingbuffett premium member - 2 years ago
Hey Michah! Good article. Quick question on Sysco, though . . . In the last 3 years I'm seeing free cash flow per share ranging from $0.48 to $1.87. Nothing close to $3.99. Am I missing something? Thanks!
Micah Martin
Micah Martin - 2 years ago

You are completely right! Thanks a lot for catching that. Despite my efforts to be accurate, the figures I wrote down for Sysco were inaccurate.

After reading your comment, I immediately edited the table and article to reflect accurate numbers for Sysco for the past three years. (To get the average of $0.76 a share FCF, I am using $0.95, $0.81, and $0.52, as their fiscal year is almost over.)

Again, thanks for the correction, Becomingbuffett!

Crastogi - 2 years ago
what growth are we talking about? FCF? Earnings? revenue?

Micah Martin
Micah Martin - 2 years ago
Hi Crastogi!

Thanks for your question. For this article, I just looked at Gurufocus’ 10-year average growth numbers for book value, revenue, EBITDA and FCF, and estimated a conservative organic growth rate for each company. I didn’t use one specific multiple, as different companies/industries use different multiples to measure their growth.

Many of the companies (and industries) above I have not researched extensively, so take my growth numbers with a grain of salt; they are merely to provide a rough estimation.


Janbil1 premium member - 2 years ago

Nice article!

Are you adjusting the FCF/share or taking it straight from

For example: MSFT on gurufocus, for the past 3 years is:

6/10: $2.52

6/11: $2.92

TTM: $3.27

AVG: $2.90

You show $3.41

I would think I'm missing something.

PEP was spot on ($3.33)

but MSFT was off and ($3.41 vs. $2.90)

so was VIAB ($3.78 vs ($1.87+$4.76+$5.14) $3.92

Please let me know what I'm overlooking on getting the average FCF/share.


Micah Martin
Micah Martin - 2 years ago
Thanks for your questions, Janbil1.

The numbers for VIAB I purposefully adjusted for this article, due to their fiscal year ending in September. By including the TTM number of $5.14 with the most recent year-end number of $4.76 as a separate figure, I would be, in essence, counting two quarters twice. I have not studied Viacom and their expected FCF for this year, so in a desire to err on the side of conservatism, I used $3.78($1.87+$4.76+$4.73) as their average FCF per share.

That said, I did indeed make a mistake with the MSFT numbers. You are right. Thank you for catching that! I edited the numbers to make them correct, and also went through every other company listed to ensure accuracy. Thank you!


Richday101 premium member - 6 months ago

Very interesting article. I just saw it and wish I had done earlier. I thought I would add a few of my comments. I disagree somewhat with your calculations when applying the analysis for individual stocks. Mr. Yacktman gave us an example of what the market is expected to do, namely 6.5% for the S&P500 when he used 2.5% FCF yield, + 1.5% real growth + 2.5% inflation (historic values of FCF growth, real growth and growth due to inflation).

However, when looking at individual companies, you can't add a historic inflation rate of 2.5% as some companies can't raise prices by this rate. In fact some companies have to constantly reduce prices (e.g. telecom, electronics industry). See what happened to Blackberry when their lost their dominant position and had to lower unit prices and subscriber rates demamded by the huge telecom companies.

I believe when Don Yacktman analyses individual stocks he uses FCF Yld + Projected FCF Gwth based on historic values for the individual company. He then adjusts the Rate of Return downwards depending on company risk factors (e.g. moat, quality, uncertainty, predictability, debt levels, etc.).

So, for Pepsi I would get:

Rate of Return = 4.9% (FCF Yld) + 7.8% (FCF Gwth over last 10 yrs) = 12.7%.

There is no need to add inflation of 2.5% as FCF Gwth has already included inflation as Pepsi has raised prices over the last 10 years which results in increases in FCF, EPS, etc. over the years.

The final step, is to calculate Adjusted Rate of Return by multiplying by a Risk Factor. I would use 0.90 for PEP as it is a very stable company.

Adjusted Rate of Return = 0.90 (Risk Factor) x 12.7% = 11.4%. In this case the values don't change much but at times it can.

Note, I did not adjust PEP FCF downward as we currently have record profit margins, something Mr. Yacktman also does in his analysis.

From your analysis you got ConocoPhillips with a ROR of 20%. I would guess both Mr. Yacktman and Warren Buffet would get much lower expected ROR. Buffet sold some COP and Yacktman has it as his 16th highest holding with a 1.9% weighting.

My calculation for ConocoPhillips (COP) using your figures would have been:

Adjusted Rate of Return = 0.60 (risk factor) x [ 8.6/53.81 (FCF yld) + 4% (FCF Gwth) ] = 12%.

We can see that the FCF for ConocoPhillips has come down drastically and unpredictability since the initial calculations. I find the adjustment for risk is very important and key to compare stable stocks with less predictable ones. I bet when Yacktman bought Blackberry he used a discount or risk factor of 0.50 or lower. I did. I bought BBRY and still lost money because I held on too long. I have found it is very difficult to make money on companies that have declining fundamentals even when you buy at a huge discount.

Thanks again for your thought provoking article.

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