The Perpetual Money Machine Strategy


The Perpetual Money Machine Strategy

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Introducing Tom Yeung’s Profit and Protection

The Moonshot Investor is going away next week.

You read that right.


But it’s not because I’ve gotten fired…

Nor is it because of markets; my top-picks portfolio has managed to outperform the Nasdaq composite by a wide 11% margin since January …

… Instead, it’s because we’re launching Tom Yeung’s Profit and Protection, a newsletter about making money during good times while protecting your earnings during the bad. It’s a letter that will cover strategic investments in quality-growth stocks at reasonable prices, and yours truly will be making the picks and calling the shots.

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Regular Moonshot readers will have already seen some of these changes.

Midcap value stocks like Martin Midstream Partners (NASDAQ:MMLP) and Volt Information Science (NYSEAMERICAN:VOLT) now feature prominently; unlike meme stocks such as GameStop (NYSE:GME) or AMC Entertainment (NYSE:AMC), these cheap companies have plenty of downside protection. And crypto coverage has declined since February when my Momentum Master strategy signaled it was time to get out.

There will also be new additions. Quant-based strategies will feature prominently. And there will be new names, from lesser known XL Fleet (NYSE:XL) — a company that trades for less than its cash value — to AT&T (NYSE:T), a household name benefiting from the consolidation of the 5G network providers.

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How to Make Money Without Really Trying

As a former Wall Streeter, I have a confession to make:

Making money in the stock market is easier than it looks.

For all the bluster from Wall Street and CNBC talking heads, picking winning stocks doesn’t require a Ph.D. or a CFA Charter.

Consider Home Depot (NYSE:HD), a company that’s easily visible to anyone driving down the highway.

A chart showing the stock price of HD stock over the last several decades.

$10,000 invested during Home Depot’s IPO would have turned into $60 million.

Or what about Norfolk Southern (NYSE:NSC), a humdrum railroad firm spanning much of the East Coast?

A chart showing the stock price of NSC stock over the last several decades.

In both of these cases, regular investors would have outperformed the market without really trying.

That’s because the secret to high returns has nothing to do with insider access…

You don’t have to be the smartest person in the room…

And it’s definitely not about working on Wall Street.

Instead, companies like Home Depot and Norfolk Southern are what I call:

Perpetual Money Machines.

And here’s how they work.

The Perpetual Money Machines of the Stock Market

Perpetual Money Machines are one of the least understood concepts of Wall Street.

That’s because the term is often confused with compound interest — the “eighth wonder of the world,” as some people believe Albert Einstein said.

Instead, the Perpetual Money Machine is a combination of:

  1. High cash-flow returns; and
  2. The ability to reinvest the returns over long periods.

Together, these two elements can help investors earn 1,000x returns with virtually zero effort.

Here’s why it works.

Imagine one day, a traveling salesman sells us a goose that lays a golden egg every day.

We’re obviously skeptical at first since we’re seasoned investors. Who ever heard of a goose that produces solid gold?

Yet, the next day, we find the goose has indeed laid a golden egg.

And the following day, another golden egg appears…

And the next… and so on.

Now obviously, we’re smart enough to avoid cutting the goose open out of greed.

So, here’s the trick — the secret that makes the Perpetual Money Machine work.

Instead of spending those golden eggs or making a golden omelet, what if we went back to the traveling salesman and exchanged an egg for another goose?

Suddenly we’re producing two golden eggs every day. That’s twice as good as before!

But why stop there? The next day, we’ll take the two eggs back to the salesman and buy another two geese.

Suddenly, we have four eggs a day!

Then eight! Sixteen! Thirty-two!

You get the idea. As long as the salesman has more geese to sell, you end up with virtually unlimited growth.

The Perpetual Money Machine in Action

Amazingly, high-returning companies have the same magical ability to produce golden eggs to buy more golden geese.

Consider Starbucks (NASDAQ:SBUX), a company that most people associate with swanky malls and overpriced lattes.

You would imagine the secret to their stunning stock market success was phenomenal marketing for decent-tasting coffee.

But that’s not all. If it were, other restaurant chains would grow just as fast.

But it turns out that another secret to Starbucks’ success is its ability to generate high internal returns (i.e., laying golden eggs).

Each new store only costs Starbucks around $250,000 per build. Forgoing the need for a dedicated kitchen means each Starbucks location has around a 1.5-year payback period — more than twice as fast as a Chipotle or McDonald’s.

And the best part? Once Starbucks earns its investment back, those profits can go towards building another new cafe… and another… and another.

It’s like using the goose’s golden eggs to buy more geese.

In fact, even after deducting marketing and overhead costs, Starbucks generates an average of 20% return on capital invested (ROIC). Removing a 6% cost of capital means Starbucks can double in size every five years with zero financial input.

Meanwhile, low-returning companies have no such luxury. Companies like Darden Restaurants (NYSE:DRI) — the owner of Olive Garden — only earn 10% ROIC. Once the 6% cost of capital gets deducted, it would take eighteen years for the firm to achieve the same growth.

Quite the difference!

How Doers Get More Done

What about Home Depot?

Unsurprisingly, it turns out the DIY hardware store has a stunningly high 40% ROIC.

A chart showing the ROIC for HD stock.

That creates a virtuous cycle. High returns are funneled into building more high-returning stores and make the company an ever-growing perpetual machine.

Buying at the Right Price

Investments in Perpetual Money Machines, however, do come with four caveats:

First, investors need to buy in at the right price. If an investor pays twice what Starbucks is fundamentally worth, it would take five years for SBUX to “grow” into that valuation. That waiting period cuts into potential returns and reduces the attractiveness of a stock.

Second, the company needs to be able to reinvest at the same rates. If Starbucks can continue to double every five years, investors will gain. But once it saturates the global market with coffee shops on every corner, no amount of excess cash flow will help the firm grow further.

Third, investors need to be patient. Even if a company’s fundamental value rises by 20% per year, its stock price could gyrate wildly between underpricing and overpricing.

And finally, there’s industry risk. High ROIC companies can easily be upended by technological or societal changes. Business history is littered with once-mighty companies like IBM, Xerox and Kodak that ended up as footnotes.

But if you find a Perpetual Money Machine that passes all four checks, you’ll know.

Getting Started With the Perpetual Money Machine

If you think this seems like a lot of information, you’re not alone.

Entire volumes of books are written on the subject of financial returns…

Graduate-level courses are taught about ROIC and its cousin, CFROI…

Even most Wall Street pros can go years without understanding how high internal returns drive long-run value.

So to get you started, here is a list of promising firms with growth, momentum and high ROIC.

A chart showing ROIC, momentum, value and total grades for BXC, NRG, HPQ, LMT, STLD, BCC and MUSA stock.

Many of these companies fly under the radar. BlueLinx (NYSE:BXC) is a distributor of industrial building products, while NRG Energy (NYSE:NRG) is a power generation firm. Not exactly your Cathie Wood brand of high-growth tech stocks.

But this type of investing works. BXC is up 824% over the past five years, while NRG has gained 172%.

Meanwhile, Ms. Wood’s ARKK Invest (NYSEARCA:ARKK) has only managed a 56% return.

Now, there will always be opportunities for hypergrowth investing. Companies like Desktop Metal (NYSE:DM) and Matterport (NASDAQ:MTTR) are on the cutting edge of tech. And smart investments in promising biotechs can turn tiny portfolios into gargantuan ones.

But for those looking to buttress their core portfolio with long-term holdings, it’s hard to beat a group of companies with sustainably high returns, bought at reasonable prices.

P.S. If you liked what you saw in this email, make sure you click here to keep receiving Tom’s emails once Tom Yeung’s Profit & Protection launches next week.

On the date of publication, Tom Yeung did not have (either directly or indirectly) any positions in the securities mentioned in this article.

Tom Yeung, CFA, is a registered investment advisor on a mission to bring simplicity to the world of investing.

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