ValuFocus Investing: A Cash-Loving Contrarian Way to Invest in Stocks

Chapter 16

Digging Deeper into the LCRT Model

In digging deeper, we are exploring some of the advanced features of the LCRT models.¹ For those who have had enough with the details of model building, proceed to Chapter 17. If you want to focus on Rawley ranges of bounded rationality, proceed to the section “Calculating Bounded Rationality (Rawley Ranges)” in this chapter. Still, we encourage you to continue reading chapter by chapter. There is much more to be learned in this chapter.

Exponential Fading of both Cash Economic Return and Growth Rate

We have mentioned earlier the concept of exponential fading. Fading both CER and growth rate has come about by investigating the nature of competition. Companies adopting new technology by deploying capital immediately find competition cutting away at that initial advantage. The innovation-based increase of cash economic return (CER) and cash flow growth rate is reduced over time as profit margins are squeezed.

As experienced investors, we must recognize this effect. The upward thrust of the new technology investment is steep initially, but then the rate of increase starts to fall and eventually levels off. As time passes, the upward thrust is negated entirely and cash flow begins to slip. Each year shows a more rapid decline in cash flows. In the later stage, the slide slows as it approaches a steady state. This is what we call an exponential decline. The decline can happen in just four to five years in a dynamic industry with short economic ...