KJP

Agreed, and it's fine if this is one of a basket.

https://www.businesswire.com/news/home/20241101796006/en/Mid-Penn-Bancorp-Inc.-to-Acquire-William-Penn-Bancorporation

Some others not already mentioned: Thomasville Bancshares (THVB) Citizens Bancshares (CZBS) United Bancorporation of Alabama (UBAB)

Clarus (CLAR)

On pipelines, WMB has irreplaceable assets and expansion opportunities so no criticism of it from me, but if someone is interested in big pipeline companies and can deal with a K-1, I would also look at Enterprise Products Partners (EPD) -- shareholder alignment, lower valuation, lower leverage, better debt profile, better tax characteristics, and significant expansion opportunities. Perhaps more controversially, I also think EPD management is more candid than WMB's about the other key variable -- returns on incremental invested capital.

TransAct Technologies (TACT). Unfortunately I think it's a lower quality business than most of the others I mentioned in my prior post, so I don't have a large position in it.

@tnathan It's not clear where you're getting tripped up. I believe these are the steps: 1. The ROIC and growth rates in the chart allow you to create a simple DCF model of cash flow to equity over time. 2. That DCF is assumed to go on in perpetuity. @EBITDAg gave you the formula for calculating the PV of a perpetuity with constant return on reinvestment and constant growth rate. 3. One input into the perpetuity calculation is usually referred to as the "discount rate". It is the "r" in the traditional denominator notation "r - g". This is normally thought of as accounting for the time value of money, risk, etc. But another way to think about the discount rate in this model is the IRR you will receive on the assumed stream of payments if you pay the price calculated by the PV formula once you put in the return. That is why footnote 1 in the paper you linked says "w = required return". In other words, if you assume initial earnings are $1, and given the stream of cash flow produced by the DCF, what price do you need to pay today to earn a 10% return? For the upper left box, that's $9.40, which is equal to 9.4x our assumed $1 in earnings. So, long story short, that chart is telling you the price you need to pay today to earn a 10% IRR on the perpetual stream of payments that would occur given the ROIC and growth assumptions. Which step above is throwing you off?

Ha! No, it’s not my chart, but it’s one I’ve seen many times. And I agree with you that the chart (or any similar chart) has to make a number of simplifying assumptions, such as ignoring taxes, that matter in the real world. And to really understand the chart you need to understand those assumptions. But I don’t think you disagree with the gist of the chart, which is that, in general, multiples are related to expected growth rates and expected returns on invested capital. That clicks for some people by reading Buffett describe See’s. That clicks for others via charts like that and the underlying formulas and mathematics, and it is the mathematics that the original poster asked about.

You are correct. My math would be for a 10% ROIC, 10% growth box, which is not shown on the chart. The math for that box is easier to show and illustrates the point that higher growth under the assumptions doesn't warrant an increased multiple. If you did the same DCF at any growth rate, it would produce the same thing under the assumption that non-reinvested cash flow is dividended out. Do you agree with that or do you think that under a 10% discount rate assumption, growth at 10% ROIC creates value and thus 7% growth would should be valued higher than 2% growth? [If you think that, why is the 10% growth box still at a 10 multiple?] To be clear, I don't think 10% is actually the discount rate that has generally prevailed in equity markets given the interest rates we've had recently.

The table isn't unique to KCM and the numbers aren't made up (though it may not be particularly useful!). The numbers come right from a DCF. The chart is using a 10% discount rate. With that assumption, growth at 10% ROIC creates no present value. Example, I earn $1 today and invest all earnings incrementally at 10% ROIC. Next year I have $1.10 in earnings. If I discount that back at a 10% discount rate, those future earnings are worth $1 today: 1.1/(1+.1) = 1. The next year will show the same thing -- I'd now have $1.21 in earnings but the present value of those earnings remains $1: 1.21/(1 + .1)^2 = 1. [At a constant multiple, the stock would also be increasing at 10% per year. That's consistent with no value creation IF you use a discount rate of 10%.] That is why, at a 10% ROIC, the 2% and 7% grower have the same multiple. If the chart used an 8% discount rate, then the 7% grower at 10% ROIC would have a higher multiple than the 2% grower, as they do in the chart for all ROICs greater than the assumed 10% discount rate.

The opening post was a bit blurry because it asked about what tends to happen in the real world and about a hypothetical that appears to contain a false premise. My explanation is only a response to the hypothetical posed in the opening post: Why will a "capital lite" company outperform [I assume this means produce higher total shareholder returns] a capital intensive company if they have the same growth rate and FCF? If you add an assumption that each company's incremental capital earns each company's historical returns, then the hypo is impossible because true FCF after capital reinvested for growth cannot be the same for both companies. That must be true given the hypothetical's assumptions about RoEs and growth rates. Most of the responses in the thread seem to get at the other question raised in the opening post: In the real world, why do capital lite companies tend to outperform over time? I think you're right that that statement is not universally true and that the key questions for the long-term return on any growing business are: "How much can the company reinvest (or acquire) and at what rates of return?"

I believe your hypothetical is mathematically impossible, and the reason why is why the capital light company will outperform. Let's assume two companies, Company A earns 50% on equity, and Company B earns 20% on equity, both grow earnings at 20%, both earn $1 in year zero, and both have returns on incremental equity that are identical to their historical ROEs. By hypothesis, Company A's starting equity will be $2 (1/2 = 50% ROE), and to earn $1.20 it would need to reinvest $0.40 of earnings from year zero (.40 * 50% = .20). It has an extra $0.60 in earnings from year zero that it can use to dividend out, buyback shares, etc. By hypothesis, Company B's starting equity will be $5 (5 * 20% = 1). To earn and additional $0.20 it needs to reinvest all $1 of its year zero earnings (1 * 20% = .2) In other words, the more capital intensive Company B would have had to reinvest all of its earnings from year zero to obtain the same 20% growth. So, if companies have different returns on equity, they can have the same earnings growth rate, but they will not have the same free cash flow left over after accounting for the earnings that had to be reinvested to achieve that growth. The difference between the amount of earnings the high ROE company had to invest versus the lower ROE company will be the source of the higher ROE ("capital lite") company's excess returns.

Probably, but nothing is immediately coming to mind.

I've had some luck with this approach. Some examples of my thoughts in real time are in these threads:

I just got back from 10 days in southern and central Idaho (Boise - Twin Falls - Stanley). I highly recommend it -- particularly Stanley and the Sawtooth Mountains -- to anyone who likes summer outdoor activities (hiking, biking, rafting, fly fishing, etc.).