The 52-Week Low Formula: A Contrarian Strategy that Lowers Risk, Beats the Market, and Overcomes Human Emotion

Chapter 5Filter 2: Free Cash Flow Yield

Jacobian Inverse: If I wanted to help ensure that my stock investment bears the risk of equity ownership but pays me less cash than the risk-free cash from a 10-year Treasury bond, then I would definitely buy companies whose free cash flow yield is in line with or less than the risk-free rate. This would help to ensure that I am buying overvalued businesses.

This leads to the correct strategy, which is to set a requirement that any company worth investing in must provide a cash flow multiple over the risk-free rate. This helps to ensure that we are buying a business with a margin of safety.

The second of the five filters that go into the 52-Week Low formula helps us determine whether a company is worth investing in at all. While the first filter was used to determine the potential for a company to remain competitive over the long haul, the second filter forces us to take a look under the hood, so to speak, to determine a company’s value as an owner and whether that potential cash flow is great enough to warrant the risk of investing in the company at all.

When it comes to buying a stock, you really want to look at your purchase as an investment in an actual business. This advice is reinforced within the book The Intelligent Investor, written by Benjamin Graham,¹ specifically in the “Margin of Safety” chapter, where he discusses that investing is most intelligent when it is most businesslike. To sum up the chapter, he states:

It is amazing ...