Columns M – O – Price To Cash Ratio

Cameron : Column M is just the current share price. And then column N is another calculation, the price to cash ratio. We’re taking the share price and dividing it by the cash per share figure that we calculated before. And this is to work out exactly what we were talking about before – how long it is going to take to generate enough cash to neutralize my investment. 

Tony : Correct. Yes. And we’re looking for a number which is equal to less than seven. So, we want our investment paid back within six years or no more than seven years.

Cameron : And that’s column O, which asks if the price per share, divided by the cash per share, is less than seven. So, let’s explain that Tony, what’s this magic number seven? I know that one is the loneliest number that you’ll ever know, two is not as bad as one, but it’s the loneliest number since the number one, by the time I get up to seven, I think that’s polygamy. By the time you get up to seven, you’re a Mormon. Where did you come up with seven? Why is seven important?

Tony : Well I once read a book about investing and it was covering a guy who ran a company called Cap Cities, which was a TV station in upstate New York. And he went around buying up other TV stations but would never pay more than six times operating cash flow for them. And eventually, it grew into one of the big networks. I think it was ABC in the US. And that was his metric. So, I’m again unashamedly stealing from someone else. 

Cameron : And the guy I think was Tom Murphy?

Tony : Yes. 

Cameron : It sounds familiar, Warren Buffet is the big fan of his, right? I think the book might have been The Outsiders?

Tony : It was, yes. 

Cameron : That’s why I’m here. Tony. Warren Buffett once said “Most of what I learned about management, I learned from Murph, Tom Murphy. I just kicked myself because I should have applied it much earlier.”

Tony : Right. 

Cameron : The book was #1 on Warren Buffett’s Recommended Reading List, in the 2012 Berkshire Hathaway Annual Shareholder Letter, and it was named one of “19 Books Billionaire Charlie Munger Thinks You Should Read” in Business Insider. So it’s probably worth reading. 

Tony : It’s really good. 

Cameron : So, the seven number, it’s just risk management?

Tony : Yes, that’s right. Like you said before, if we were paying six times operating cash flow for the coffee shop, we expect to get our money back after six years. And obviously you want that to be as low as possible. So, when we come to ranking companies, the lower that price to operating cash flow the better.

Cameron : Because it’s pretty hard to predict. I mean, people are still going to be drinking coffee seven years from now, probably, but what’s going to happen to trends in coffee shops? Are baristas going to have like long square beards, short beards, or Hitler mustaches? We don’t know. Things can change a lot. The longer the timeframe, the more things can change. 

Tony : More importantly, another coffee shop could open up across the road and take half our business.

Cameron : With stripper poles at the front like The Bada Bing.

Tony : Yeah. So, we want our money back as soon as possible before the unknowns can destroy our business.