🎓 Can This Formula Really Predict Your Investment Returns?

An in-depth look at Yacktman’s "Forward Rate of Return" and its ability to forecast long-term investment performance.

Mar 02, 2025

In investing, it’s good to look at the past, but it’s even more important to look ahead. Yacktman’s Forward Rate of Return (FRR) is a powerful tool that helps investors estimate future returns. This concept was developed by investor Don Yacktman and has become a valuable tool for those seeking a solid long-term investment strategy.

In this article, we will dive deeper into the FRR, explain the formula, provide concrete examples, and discuss the pros and cons of using this method.

What is the Forward Rate of Return?

The Forward Rate of Return (FRR) is a way to estimate what kind of return you can expect from an investment over time. Yacktman defines the FRR as the free cash flow yield, plus the real growth of the company, plus inflation. This method helps investors get a clearer idea of the returns they might see, based on the company’s cash flow and growth, rather than just focusing on market fluctuations. By using the FRR, investors can make better predictions about future returns, considering both the company’s financial situation and broader factors like inflation. This makes it a useful tool for building a more solid investment plan.

The FRR formula

The FRR is calculated by combining the following elements:

The Forward Rate of Return = Free Cash Flow Yield + Growth + Inflation

Where:

Free Cash Flow Yield: The free cash flow yield is calculated by dividing the total free cash flow by the company’s market capitalization.
Growth: This is the estimated annual free cash flow growth of the company over the next 5 years.
Inflation: The expected annual inflation rate for the next 5 years.

Concrete examples

Let’s now calculate the forward rate of return for the following two companies:

Nvidia
Here are the data for Nvidia (source: koyfin.com):

Total Free Cash Flow: $60.86B
Market Capitalization: $3,048.05B
Estimated FCF Growth over the next 5 years: 22.0%
Estimated Inflation Rate: 2.5%

FRR = $60.86B / $3,048.05B = 2.0% + 22.0% + 2.5% = 26.5%

This means Nvidia is expected to generate an annual return of 26.5% over the next 5 years, based on its current market capitalization, free cash flow, growth expectations, and inflation estimates.

Lululemon
Here are the data for Lululemon (source: koyfin.com):

Total Free Cash Flow: $1.59B
Market Capitalization: $44.38B
Estimated FCF Growth over the next 5 years: 4.3%
Estimated Inflation Rate: 2.5%

FRR = $1.59B / $44.38B = 3.6% + 4.3% + 2.5% = 10.4%

This means Lululemon is expected to generate an annual return of 10.4% over the next 5 years, based on its current market capitalization, free cash flow, growth expectations, and inflation estimates.

Advantages of the FRR

The Forward Rate of Return has several advantages:

The FRR gives investors a more realistic view of what they can expect from their investment in the long term, based on the company’s cash flow and growth expectations.
The formula is relatively straightforward to apply, making it accessible for both beginner and experienced investors.
With the FRR, investors can compare different stocks or markets based on their expected returns, helping them make more informed decisions.
The FRR helps investors focus on the underlying business fundamentals instead of short-term market fluctuations, which are often difficult to predict.

Disadvantages of the FRR

In addition to its advantages, the FRR has some important drawbacks:

The FRR relies heavily on the accuracy of the growth expectations and free cash flow estimates used. Incorrect or overly optimistic assumptions can lead to misleading predictions. It’s important to remember that the future is uncertain, and changes in market conditions or company strategies can significantly affect actual growth.
The FRR does not account for market volatility or unforeseen external factors such as economic recessions, geopolitical events, or changes in consumer behavior. These can significantly affect a company’s performance, even if free cash flow and growth projections appear favorable.
The FRR is partly based on historical performance, which may not always be a reliable indicator for the future, especially in fast-changing industries. What worked in the past isn’t always a guarantee for future results. Innovations or disruptions in the market can quickly make existing business models obsolete.

The Forward Rate of Return is a valuable tool for investors looking to estimate future returns based on a company's financial health and expected macroeconomic conditions. Don Yacktman’s approach helps investors focus on long-term fundamentals rather than short-term market fluctuations. While the FRR can be a useful tool, it is essential to approach it with caution and integrate it into a broader investment strategy. It’s important to use multiple tools and analyses, as market conditions can be unpredictable.

Source: GuruFocus, Koyfin

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