Since I began using GuruFocus several years ago, I have regularly come across the Yacktman Forward Rate of Return in the Valuation & Returns section of summary pages for many stocks.
I confess that I have not given it much attention since it has always seemed more of a bond metric than a stock metric. But my curiosity has grown and I have decided it is time to figure out who this guru is and why I should be interested in his forward rate of return (FRR).
In discussing forward rate of return, we will discover what it is, how it is calculated and how to use it in analyzing stocks. First, start with a look at the man behind the name.
Yacktman biography
Donald Yacktman (Trades, Portfolio) began his investing career at Stein Roe and Farnham in 1968, after graduating from Harvard Business School. He spent 14 years there as a portfolio manager before moving to Vincent Chesley, where he took over Selected American Shares. While there, he grew his portfolio from $76 million to $400 million in eight years. His annual returns were exceptional and he earned “Portfolio Manager of the Year” honors from Morningstar in 1991 (based on information on the Donald Yacktman Resource Page at ValueWatch).
He started The Yacktman Fund (Trades, Portfolio)s in 1992. The following year, his son Stephen joined him in the business and has since taken on increasing responsibilities. On May 1 of this year, a notice on the company website said Donald Yacktman (Trades, Portfolio) “will move to an advisory role,” as a planned step in a long-term transition plan. It also advised, “Donald will remain a partner of Yacktman Asset Management, maintain his ownership stake and continue to oversee separate accounts where he has long-term relationships.”
Active management of the fund transferred to his son Stephen, Jason Subotky, Russell Wilkins and Adam Sues in what appears to be a collegial management structure.
The firm manages four funds and an investment management service:
- AMG Yacktman Fund (Trades, Portfolio)
- AMG Yacktman Focused Fund (Trades, Portfolio)
- AMG Yacktman Special Opportunities Fund
- Heptagon Yacktman U.S. Equity Fund (UCITS fund)
- Institutional and privately managed separate accounts
The Yacktman way
“When we buy something, we try to look at it as if we were buying a bond,” Yacktman told Barrons in an interview published on May 22, 2010. He also said, “If a bond [price] declines, its yield goes up. So if a stock declines, its forward rate of return goes up.” Barrons noted,
“He equates this forward rate of return with a company's free-cash yield. He calculates this yield by estimating how much cash the company has left after spending what it needs to maintain its business, then adds in the cash he believes it can generate through growth and adjusts for the effect of inflation. That figure is then divided by the stock price.
“Then, just as a corporate-bond investor does, Yacktman compares the stock's forward rate of return with yields on long-term Treasuries. Based mainly on the spread between the two, he assigns a quality rating to the stock.”
Within that context, it might be said that the Yacktman strategy is buy good growth companies at value prices. The company website says they are looking for stocks that have at least one of the three following attributes:
- a good business
- shareholder-oriented management
- a low purchase price
Good businesses are expected to have one of more of these characteristics: high market share, high cash return on tangible assets, relatively low capital requirements, short customers repurchase cycles, long product cycles and unique franchise attributes.
Shareholder-oriented managers do not overcompensate themselves, allocate cash wisely, reinvest in the business and still have excess cash, make synergistic acquisitions and buy back shares.
Low purchase price means the stock sells for less than an investor would pay to buy the whole company, and shares should only be bought when prices are near the lows of a high-low cycle.
In comments quoted at the Profile & Performance page, Yacktman says,
“We buy growth companies at what we believe to be low prices. We think this approach combines the best features of 'growth' and 'value' investing.”
To see annual and cumulative performance results of his funds, see the Yacktman Profile & Performance page.
Note while reading the performance charts that this firm really emphasizes the long term. In a 2012 interview with GuruFocus,Ă‚ Yacktman said,
“I can’t overemphasize the importance of patience. So many people in this business think in terms of 10 minutes, or 10 hours, or 10 days, or 10 weeks, or 10 months, not 10 years. Very few people have the inner strength or patience to wait it out.”
GuruFocus sums up Yacktman's metric this way, “The forward rate of return can be thought of as the return that investors buying the stock today can expect from it in the future.”
The forward rate of return formula
A reference to the formula is above. It is also calculated for stocks covered by GuruFocus in the Valuation & Returns area of a company's summary page.
Clicking the linked name, Forward Rate of Return, takes the user to a GuruFocus page devoted to explaining and calculating the current and recent numbers. Here is what the top of the page for AMETEK Inc. (AME, Financial) looks like:
On that page (or the same page for most stocks), not only will data on that company’s forward rate of return be found, but information about the measure and why it matters. Start with the two components of the formula:
“For the growth part of the Forward Rate of Return calculation, GuruFocus uses the lower of total revenue growth or per share revenue growth, and the growth rate is always capped at 20%.”
“For the Free Cash Flow we use per share data averaged over seven years. The reason we use seven years is because research shows that seven years is the length of the typical business cycle.”
In calculating the forward rate of return, GuruFocus also adds in an inflation factor: “Yacktman defines forward rate of return as the normalized free cash flow yield plus real growth plus inflation.”
GuruFocus raises a couple of flags in its calculations of forward rate of return:
- “. . . the calculation is reliable only if the company can grow at the same rate in the future as it did in the past. Investors should pay close attention to this when researching growth stocks. More accurate measurement return returns are Return on Capital.”
- “For the Free Cash Flow we use per share data averaged over seven years. The reason we use seven years is because research shows that seven years is the length of the typical business cycle.”
Comments by Donald Yacktman and Russell Wilkins
Here are some thoughts from Yacktman and Russell Wilkins in the 2012 interview with GuruFocus:
“So the process is then really a function of looking at the cash flows of a company. Most good companies generate cash, and that usually consists of two components; payout and return on retained earnings. Payout is the dividend and net share repurchase. Reinvestment rate is really the wild card in equity investing.”
“[Question from GuruFocus:] So basically you look at what the company did in the past with the extra cash they have, what they have done with that cash to predict what they might do in the future?
“Russell Wilkins: We found what they’ve done in the past is a much better predictor of what they’re going to do in the future than what they say.
“Yacktman: The other thing is to really understand the business model. Most of the time the good businesses will make the managers look like stars, rather than the other way around. I remember one of my children said to me once, after dinner when we were talking about investing, “Now let me see if I have this right, Dad. Basically what you’re saying is if you buy above average businesses at below average prices, then on average it’s going to work out?” I said, “Yes, that’s basically it.””
Some of Yacktman’s comments from the 2012 interview with GuruFocus were also published a few weeks earlier on Aug. 1. This part of the interview focused on identifying high quality companies:
“[Question from GuruFocus:] What’s your definition of a high quality company?
“Yacktman: "I would make it a function of high return on asset businesses. In other words, the businesses that have the sustainability to earn high returns on assets, I think they are the high quality businesses. And if you were to take your piece of paper and use two axis, one would be fixed assets, the other economic sensitivity, you could plot any company on there. The companies that have low capital intensity and low cyclicality like Coke (NYSE:KO) or Pepsi (NYSE:PEP), you can go on and on, Proctor & Gamble (NYSE:PG) certainly, those businesses have the ability to earn some of the highest returns out there. What you’re looking for is not only both the low asset requirements and low cyclicality but in addition to that, and that usually means a disposable type product or service, it also means you have a large market share.
“Proctor & Gamble, while struggling in the short term, no question about it, it’s disappointed people and they haven’t been able to get gross margins up, they’re various reasons for that. But I think the reality is when you have 50% of the detergent market in the U.S., somebody else can’t take it from you. You can blow it, but they can’t take it from you. And what happens is when you have those market shares, 40% market share versus 20% market share, you don’t earn twice as much, you earn 4 times as much. Because what happens is your cost structure gets to be lower and lower, relative to your competition. And you can spread your costs across more units.”
Conclusion
Yacktman’s Forward Rate of Return may or may not be a useful metric. However, it does present new ways to see and think about stocks we may want to buy.
The forward rate of return allows an investor to consider stocks in the same context as bonds. What will this security be worth in the future? This would have more value during an age in which bond yields mean something, when one might compare stocks and bonds side by side, comparing yields and seeing how much of a risk premium might be received for buying a stock rather than a bond.
I also find forward rate of return useful as a means of comparing the future rewards of two stocks. We can have that, to a certain extent, with discounted cash flow but forward rate of return provides another useful perspective.
It is notable as well that Yacktman sees forward rate of return as combining the best of growth and value investing strategies. That offers a new line of inquiry for investors looking for opportunities to grow more aggressively, while not necessarily compromising on risk.
Summing up, forward rate of return is another tool that can be deployed when making important decisions. In searching out value stocks, and particularly value stocks with a growth bent, Yacktman’s Forward Rate of Return is a helpful way to think of and research investments.
Disclosure: I do not own shares in any of the companies listed in this article, nor do I expect to buy any in the next 72 hours.
Start a free 7-day trial of Premium Membership to GuruFocus.
