Unit Economics: The Root of Free Cash Flow and Quality Investing

During their latest episode of the VALUE: After Hours Podcast, Taylor, Carlisle, and Mowery discussed Unit Economics: The Root of Free Cash Flow and Quality Investing. Here’s an excerpt from the episode:

Tobias: How long have you been in business for, Kyle?

Kyle: This is year 12.

Tobias: You say you launched right at the peak of the– Yeah. So, what’s year 12? 2011?

Kyle: Well, I just launched when I graduated business school. It was I didn’t try and time. I timed the entrepreneurial risk rather than the value cycle.

Tobias: How have you found it investing through what’s been a pretty–? You’ve had a headwind anyway, not to say that you couldn’t have outperformed, but you’ve had a headwind.

Kyle: Definite headwind. I think that unit economics is the root of free cash flow, and I think unit economics took me a while to get there, but willing to take some duration. When you’re looking at a business, really great business, out a couple of years, I think so many value guys, they get into the game. You’re trying to find a net-net, and then you’re trying to find a classic value cheap on free cash flow, cheap on earnings. I don’t think I’ve gone as far as down the quality spectrum as many, especially those who have grown their businesses a lot in the last five years, six years. But I do think with the focus on unit economics, you do pick up a little bit more of the quality factor. As we all continue to try and grow and improve our skills throughout our careers, it’s been helpful. It hasn’t been panacea or silver bullet, but it’s certainly been helpful to get, so you’re not completely fighting tech or quality.

Jake: I, sometimes, wonder from an evolution process of markets and what’s worked and the winnowing of– The more that you leaned quality as a “value guy,” you got to make it to the next round evolutionarily. It makes me wonder then, “Okay, if everyone who’s survived is quality, does that leave the opportunity then back to the guy who’s looking for back to price to book?” [laughs] We’re back to the old days again.

Kyle: I’m incentivized to say yes, because that’s the business I’m running. I have a friend. He does smaller things and hairier things than I do. He dubbed it The Last of the Mohicans. He’s like, “There’s only a handful of shops that even look at the way–” If I said replacement cost to a professional allocator now, many would just look at me funny where when I got in the business replacement cost. That’s a very standard value investing like, “What’s the replacement cost?” I literally had a client tell me that he never wanted me to say that word again about five years ago.

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