A hurdle rate of 25% is really high. Do you ever find something priced so cheaply? I guess it must really be a niche company, because anything that’s remotely known, can’t have an expected return this high. Correct?
Special situations. Structural turnarounds. But usually under the radar stuff. Or, like in 2022, when tech was underwater. But those kind of opportunities are rare.
A high hurdle rate is a weapon. It forces you to stay patient, disciplined, and avoid getting sucked into mediocre opportunities. Constellation focuses on execution and capital allocation. If you're not actively making what you buy better, you're already at a disadvantage. So yeah, set a high bar, but make sure you're holding your own feet to the fire too. Otherwise, it's just another number.
I am just concluding a post on the cost of capital, cost of equity and an intriguing tale dating back to 1916 that brings it all together. It ties in perfectly with your thoughts and reflections here, but takes a different perspective. I hope to publish next week, so keep a look out for it.
Great article and it got me thinking outside the square. As dumb as it makes me appear, I had never thought of it as a natural way of culling 'maybe's' into 'possibles worth investigating further' and saying 'No' and moving on.
The only caveat I would add is that this thought process needs to also work within a portfolio where your risks are spread over a number of industry sectors and not just one, say technology.
Also FWIW, I short cut the WACC issue by taking their known borrowed interest rate and I add on 1.5% to cover the costs of refinance, incidentals & management time. Plus, where acquisitions are involved I look critically at the acquisition cost (including earn outs assuming the maximum) divided by the potential EBIT as stated but I deduct 5% because of the costs of bedding down and natural attrition. If this figure is less than the current Enterprise value divided by their existing EBIT I am happy, if not one must consider the reason for acquisition more fully. In my experience, the mooted cost savings rarely play out as is stated publicly by management. Incidentally I use an Enterprise Value/EBIT of 7 as a screening tool because this equals that 15% hurdle rate.
A hurdle rate of 25% is really high. Do you ever find something priced so cheaply? I guess it must really be a niche company, because anything that’s remotely known, can’t have an expected return this high. Correct?
Special situations. Structural turnarounds. But usually under the radar stuff. Or, like in 2022, when tech was underwater. But those kind of opportunities are rare.
A high hurdle rate is a weapon. It forces you to stay patient, disciplined, and avoid getting sucked into mediocre opportunities. Constellation focuses on execution and capital allocation. If you're not actively making what you buy better, you're already at a disadvantage. So yeah, set a high bar, but make sure you're holding your own feet to the fire too. Otherwise, it's just another number.
I am just concluding a post on the cost of capital, cost of equity and an intriguing tale dating back to 1916 that brings it all together. It ties in perfectly with your thoughts and reflections here, but takes a different perspective. I hope to publish next week, so keep a look out for it.
Will do!
Great article and it got me thinking outside the square. As dumb as it makes me appear, I had never thought of it as a natural way of culling 'maybe's' into 'possibles worth investigating further' and saying 'No' and moving on.
The only caveat I would add is that this thought process needs to also work within a portfolio where your risks are spread over a number of industry sectors and not just one, say technology.
Also FWIW, I short cut the WACC issue by taking their known borrowed interest rate and I add on 1.5% to cover the costs of refinance, incidentals & management time. Plus, where acquisitions are involved I look critically at the acquisition cost (including earn outs assuming the maximum) divided by the potential EBIT as stated but I deduct 5% because of the costs of bedding down and natural attrition. If this figure is less than the current Enterprise value divided by their existing EBIT I am happy, if not one must consider the reason for acquisition more fully. In my experience, the mooted cost savings rarely play out as is stated publicly by management. Incidentally I use an Enterprise Value/EBIT of 7 as a screening tool because this equals that 15% hurdle rate.
Thanks for sharing the shortcut! I hadn't thought about it. I do the same with the EV/EBIT value 😉