Payback Theory

Payback Theory

Payback Theory 150 150 JP

Let’s say you live in a town with two bakeries for sale at $1 million each. Both offer similar products with almost exactly the same type of customer and asset structure — one earns $100,000, the other $150,000.

Which one do you buy?

The one that makes more money! That one has the highest yield, which in this case is the second bakery. In fact, if these numbers held up, bakery number two would pay you back in less than 7 years, a full 3 years ahead of the first one.

To know whether an asset is worth buying, you have to know the profit it generates compared to the price you’re paying, otherwise you’re simply speculating on whether or not you can sell it at a later date for a higher price. Not all art or Jordan sneakers fetch higher prices.

For example, if you buy a house for $500,000 and lease it for $2,500 a month, the annual yield before expenses is 6%. For private businesses its the profit for the price you paid. However, in the public markets, companies listed on big exchanges like the NYSE or NASDAQ tend to remain in business a lot longer and are thus valued at higher multiples of earnings. This means looking for growth potential at a fair or discounted market price.

Very rarely will investors acquire shares in an excellent growth company at current high yield prices. These companies must grow into the high yield prices.

Apple (AAPL)

Value: $76 billion
Profit: $6.1 billion
Yield: 8.0%

Apple (AAPL)

Value: $1.01 trillion
Profit: $56 billion
Yield: 73.9% on 2008