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Cash flow over taste
Qualitative checks come first. Once a target clears them, the decision is about IRR and the other measures of compounding, along with opportunity cost. Whether the market will like a purchase barely comes up. When two opportunities offer almost the same IRR on projected free cash flow, the one the market likes more gets the nod. A business bought only because other people like it can leave its owner stuck with something it does not want.
Teledyne's two eras
Taste in the market shifts. Henry Singleton built Teledyne in a decade or two when conglomerates were popular, aggregating assets under one umbrella. Later the market decided narrow, sharp businesses were more appealing, and Singleton began optimizing and spinning off businesses. Teledyne kept compounding very efficiently with exactly the opposite approach.
How multiples compound
Valuation is a multiple times earnings, and both halves move. If better capital allocation makes EBITDA twice or three times as large in a few years, a somewhat lower multiple still comes out far ahead, because small differences compound exponentially. The multiple also depends on the growth rate. Faster growth could offset the markdown for a portfolio the market likes less, and may leave the net multiple bigger.
How did Teledyne compound so well?
Henry Singleton co-founded Teledyne in 1960 and built it through hundreds of acquisitions. William Thorndike's book The Outsiders reports that Teledyne shareholders earned a compound annual return of about 20 percent from 1963 to 1990, well above the S&P 500. Singleton also repurchased a large share of the company's stock in the 1970s, when he judged it cheap. He ran Teledyne with almost no investor relations and little attention to Wall Street's preferences.
Why do small rate differences matter so much?
Compounding multiplies results year after year, so a small edge in the annual rate grows into a large gap. One dollar growing at 7 percent a year for 30 years becomes about $7.61. At 8 percent it becomes about $10.06. A single percentage point in the rate adds roughly a third more to the final amount.
Why does IRR favor money that comes back sooner?
Internal rate of return is the discount rate at which the present value of an investment's cash flows equals what was paid. Cash that arrives early counts for more, because it can be reinvested sooner and for longer. Two deals returning the same total can have very different IRRs if one pays out in year two and the other in year ten.
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