Rule #1 by Phil Town

Author:Phil Town
Language: eng
Format: epub
ISBN: 9781409060048
Publisher: Random House Group Limited

It’s because a history of growing equity shows that the business has been able to create more and more surplus cash each year. Such growth of surplus cash is what makes a business valuable to the owner, because the real value of a business is just all the money you can collect from it over the years. Think about it for a second: If the Laundromat you just paid $100,000 for doesn’t produce surplus cash, what do you get out of owning it besides free starch in your shirts? Nothing. Zero. Because all the earnings per share are getting plowed back into the business to keep the doors open. If that keeps up forever, you’re never going to see a dime out of this deal, are you? On the other hand, if this Laundromat that you paid $100,000 for produces $20,000 in surplus cash this year, that means the equity grows by that much. The value of the business obviously increases with the increase in the value of the equity; a business that’s growing its cash surplus at 20 percent a year has more cash for the owner each year. That’s why Warren Buffett says in his 2004 chairman’s letter that the best proxy for the growth of intrinsic value (Sticker Price) is the growth of equity.

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