Free cash flows: Consistent Compounders Portfolio

In our previous part of the story, we learnt about the primary drivers of free cash flows. Here we will see how investors may become a victim of incomplete understanding which can impact their valuations. Why focus only on free cash flows in the case of Consistent Compounders? In Marcellus' Consistent Compounders Portfolio (CCP), there are several companies whose growth in free cash flows tends to be far greater than the growth in their profits. As shown in the table 'Free-cash-flow growth vs earnings growth...', FCFF (free cash flow to the firm) CAGR of our portfolio companies (ex-financials) has been 11-12 percentage points higher than the earnings CAGR consistently over the past five, 10, 15 years. As a result, investors focusing on only the income statement or profits of these companies often get an incomplete understanding of their competitive advantages and hence valuations. A combination of the following three reasons makes most companies in Marcellus' Consistent Compounders portfolio akin to Type 3 companies defined in the previous story. 1. Focus on in-house manufacturing and distribution of products and services which are of day-to-day essentials Our portfolio companies sell essential products and services such as pathology diagnostics, infant milk powder, undergarments for daily wear, OTC medic

This article was originally published on December 28, 2021.