Among the criteria Donald Yacktman, conservative value investor who runs the risk-averse Yacktman Asset Management, uses to judge the attractiveness of a stock, he strongly prizes a high “forward rate of return.”
Mathematically, the forward return rate equals the normalized free cash flow divided by the price, plus the growth rate of a company. This formula indicates what kind of return he can expect in the stock performance of a company.
He and one of his portfolio managers elaborated on the application of the metric in their 2012 interview with GuruFocus:
Wilkins: It is important to calculate a normal growth rate. You may need to use a multi-stage model for companies that have high short term growth.
Yacktman: And recognize that when you start getting those off-the-charts, high growth numbers, it’s not going to last. Most businesses are difficult to project many years out. Growth is really critical because the rate of return on marginal units is very, very high. But the problem is that the market has a central tendency to overprice things, and put very high multiples on companies that are growing quickly, even if it is for a short period.
Forward rates at double digits or higher are considered high. As of the third quarter, Yacktman’s forward rates of return for the largest positions in his portfolio are: Twenty-First Century Fox (FOXA) 2.3%, Coca-Cola (KO) 14.29%, PepsiCo Inc. (PEP) 10.67%, Exxon Mobil (XOM) 14.71 and Oracle Corp. (ORCL) 20.84%.
Of course, a high rate of return alone does not say enough about a company, as Yacktman factors in other qualitative and quantitative aspects in his primarily bottom-up investing process. These include low earnings multiples, price, position of prominence in its industry, business model, risk and free cash flow, among others.
According to the All-in-One screener, the following large and mega-cap stocks have the highest rates of return below 20 of all U.S. companies, and may merit additional research, though none have yet made it into Yacktman’s portfolio.
Allergan Inc. (AGN)
Allergan Inc. has a forward rate of return of 19.99%.
With a $32.5 billion market cap, Allergan is a health care company developing pharmaceuticals and medical devices. It is also the maker of such leading products as Botox, Juvederm and Lap-Band.
Allergan’s share price gained 21% over the past year to trade around a 10-year high at $109.76 Thursday. Its price to earnings multiple is 33.4, lower than 61% of the companies in its industry. It also has a P/B ratio of 5.4 and P/S ratio of 5.3.
In the past 10 years, the company produced per-share growth rates of 12.2% for revenue, 24.5% for EBITDA, 11.2% for free cash flow and 22.6% for book value.
FedEx Corp. (FDX)
FedEx Corp. has a forward rate of return of 19.71%.
A package delivery service, FedEx’s market cap is $44.34 billion, and its share price rose 54.5% over the past year to near a 10-year high at $143.40 per share.
FedEx has a P/E ratio of 27.5, higher than 54% of the companies in its industry. It also has a P/B ratio of 2.6 and P/S ratio of 1, close to a five-year high. The 10-year per-share growth rates of FedEx are 5% for revenue, 2.9% for EBITDA and 6.5% for book value.
Amazon Inc. has a forward rate of return of 19.6%.
The stock price of Amazon, the giant online retailer, is $401 per share, after gaining 57% over the past year, and market cap $185 billion.
The company produced the following 10-year per-share growth rates: 30.2 for revenue, 26.1% for EBITDA and 15 for free cash flow.
Amazon has a P/E ratio near a one-year high at 1,411.2 and P/S ratio near a five-year high at 2.63. All three ratios are higher than the majority of their industry peers.
Taiwan Semiconductor Manufacturing Co. Ltd. (TSM)
Taiwan Semiconductor Manufacturing has a forward rate of return of 19.55%.
Taiwan Semiconductor develops and sells integrated circuit related products. The company has an $89.09 billion market cap, and its share price edged up 1.36% over the past year to $17.18 per share.
Ten gurus hold shares of the company, with half of them buying the stock or increasing their positions in the third quarter. Richard Pzena initiated a stake, and Howard Marks and Jeremy Grantham made the largest increases to their holdings.
In the past 10 years, the company had the following growth rates: 8.6% in revenue, 8.1% in EBITDA and 7.2% in free cash flow. The free cash flow decline rate was 10.8%.
The company’s P/E ratio is lower than 77% of other companies in its industry at 14.4. Its P/B ratio at 3.3 is near a three-year low and P/S at 4.6% is near a two-year low.