@Transversal and @MarsC, I missed most of the subsequent...

@Transversal and @MarsC,

I missed most of the subsequent discussion around the issue of FCF Yield, and the appropriate derivation of that FCF figure when using either Market Capitalisation or Enterprise Value as the denominator.

Almost as a force of habit, and because it is the more conservative approach, I have usually used FCF (after interest payments) divided by EV.

In 99% of the time this "double counting" - of including Borrowings in the denominator as well as Interest Expense in the numerator - has not created too much of a distortion, because most companies in which I like to invest have relatively small debt levels relative to their market values. Also, in recent decades, the cost of borrowings has been low, meaning the Interest Expense is invariably not overly meaningful compared with Free Cash Flow.

But I see this default (read, lazy) approach doesn't work for companies with TCL's capital structure, which results in large distortions in FCF/EV depending on whether or not Interest Expense is included in FCF calculations.

I think that the accurate thinking is best summarised for the layman in the following statement from @Transversal:


"... if you buy the equity of a company, what you get is Earnings; if you buy the equity and the debt, what you get (before tax) is [Pre-Tax Earnings + Interest]."

So I now agree with you, the more relevant prospective FCF Yield is of the order of magnitude of 5.0% to 5.5%.

However, on residual point which I will struggle to concede ground relates to your choice of an appropriate bond against which to compare for purposes of valuing TCL, namely the 2040 indexed bond.

I'm not sure too many market practitioners would invoke that as a benchmark; instead, I think the 10-Year, being by far the most commonly quoted, is the better reference point if for no reason other than for contextual familiarity.

And in that context, on the revised FCF/EV yield it implies a spread of some 250bps of the current 10-Year yield of 280bp.

Which offers a lot more wiggle room for bond yields to continue rising before TCL would start to look expensive, compared to my initial flawed analysis, so I'm pleased the errors of my ways have been pointed out to me.


Note: In all of this discussion, please don't for a minute think I am questioning the quality of the business or the people that manage it. I think it is a thing of beauty. In fact, I own shares in TCL and I seek to own more. To that end, all I am trying to do is to preempt the way the market will respond to rising interest rates in its treatment of TCL.

And, notwithstanding that the stock might look attractively priced today, if interest rates keep going up, I suspect the market will continue to sell the stock. So I am trying to determine in my mind at what level the rubber band of valuation discount would become fully stretched so that I might be able to add to my holdings.