I like making money. I’m not always good at it. But, there are a couple of pockets I enjoy.
When people tell you a stock is going to go up, 99% of the time you can silently categorize all their explanations into two drivers:
- Company growth
- Multiple expansion
Company growth is exactly what it sounds like. They’ll say people love this product. Usage is growing. Profits are growing. Something new is coming. It all nets out to, this thing is becoming larger and more valuable.
The second driver is the multiple. A multiple is really just a measure of how excited investors are about a company’s future. It tells you how much people are willing to pay for each dollar the company makes.
Take SpaceX. It will go public at 100x revenue, implying an enormous optimism about its future. Elon has earned that optimism. But compare that to Amazon, which went public at roughly 3x revenue. A major difference is how much investors believe in the growth story. How excited the market is. The market is expecting Elon to 100x revenue.
Another way to think about multiples is that you do not need the company to grow at all. You simply need someone else to become more excited about it in the future. Before we understood AI, only a few people were excited about the future and willing to pay for it. Now, the whole market seems to understand it and everyone is willing to pay higher and higher prices to get a piece of the pie. The stock price can rise even if the underlying business hasn’t changed.
Many fortunes have been made this way. Investors identified a trend early, bought before the market cared, and then watched as enthusiasm increased and valuations expanded.
In AI we’re seeing both at once. The companies are genuinely growing at extraordinary rates. But the excitement attached to each dollar of growth is increasing even faster than the growth itself.
Imagine a company that adds $5 of value through growth. If investors used to pay $10 for each dollar of growth and now pay $20, the impact on price has two ratchets, one for growth, one for enthusiasm.
What often gets overlooked, however, is a third driver of returns:
- Capital returns
This is the cash that businesses give back to shareholders through dividends and stock buybacks.
Take Apple. During a period when the stock increased roughly 10x, I broke down where those returns came from. The business itself had grown substantially (~3x). The multiple had expanded as well (~3x). But an even larger portion of the return came from Apple returning cash to its owners (~4x).
Apple bought back stock, so every shareholder owned a larger percentage of the company. You did not have to do anything. Your ownership stake simply increased over time as shares disappeared.
That is the hidden third lever.
When I look at today’s market, most investors are focused on the first two levers.
Will Anthropic, Nvidia, Marvell, or some other AI company grow even faster than they already are? Everyone is trying to read the tea leaves.
When Google announces an equity raise for new data center spending, investors immediately start trying to decipher what that means for suppliers. They’ll model how much will flow to Micron, SK Hynix, networking vendors, power suppliers, and infrastructure providers. They’re all trying to figure out whether or not these companies will grow even more than we think.
At the same time, everyone is also trying to predict the multiple, i.e. the bubble.
Is there still money on the sidelines waiting to jump in? Will some breakthrough news come out that gets people even more excited to pay higher prices? Or, maybe we’re approaching the top? Nobody wants to be the last buyer at 100x revenue when the next buyer is only willing to pay 90x. So we hem and haw, and we try to find conviction.
These are important questions.
They are also extremely difficult questions.
That is why I spend a lot of time thinking about the third lever.
A good example is movie theaters.
A few years ago, there were four major theater chains: AMC, Regal, Cinemark, and Marcus. AMC and Regal were in bankruptcy or close to it, but Cinemark and Marcus were both strong operators. The industry was declining, but both of those businesses produced good cash. You didn’t have to worry about new competitors, no one is starting a new theater chain today.
So, the central question was simple: would movie theaters survive?
From a growth perspective. Nope, nada. Not expecting growth. From a multiple perspective, things looked even worse. Investors had zero interest in owning movie theater stocks. The sector was wildly unpopular.
But the third lever told a different story.
Cinemark and Marcus were both well-run businesses generating significant cash flow. At the prices available at the time, they were producing cash yields of roughly 20%. In other words, if you bought the entire company for $100 million, it would generate about $20 million of cash *after expenses*.
The exciting thing was that management had nothing to do with the cash. The industry already had more screens than it needed. You’d be sick in the head to put cash into standing up new multiplexes.
Sure, they could renovate existing locations, install recliners. But beyond that, there were not many attractive investment opportunities.
So what happens when a business generates a lot of cash and has nowhere productive to deploy it?
It gives it back to shareholders.
The companies bought back stock. They paid dividends. Year after year, shareholders owned a larger percentage of the business.
And yet the market largely ignored it.
Over the following years, stock owners collected dividends, watched the share count shrink, and benefited from improving economics per share. Cinemark ultimately is up 2.5x and probably has more to go. It’s not sexy, but you only had to watch one number (box office) and you could soundly put your entire net worth into that investment and not worry about someone else paying more or less for it. The company would pay you for owning it. You could sleep well at night.
So, if you can correctly predict growth, you can make a lot of money.
If you can correctly predict multiple expansion, you can also make a lot of money.
But both are a very hard game that I am rarely good at.
Capital returns are easier.
Sometimes you can find a stable business that generates substantial excess cash, has limited reinvestment needs, and is committed to returning capital to shareholders. The math becomes easier to understand, and the outcomes often feel more predictable. A current example of this is I have a large percentage of my portfolio in is a stock called $PBI. They sort mail. USPS mail. It’s as unsexy as it gets. There’s nowhere to grow, but every dollar they make they keep giving back to me. That’s a good business.
I often say there’s more than one way to get to heaven. In the stock market, everyone has to play their game. This post is me sharing an example of one of my games. And when I play this one, I feel just fine not paying attention to the daily market news.
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