Warren Buffet’s Secret Weapon (and how I made $53M using it)

Summary

• The number one metric I recommend tracking for businesses is net free cash flow, which Warren Buffett also values highly.
• Net free cash flow is the money that a business owner can withdraw after reinvesting sufficient funds to maintain and advance the business's competitive edge.
• Initially, many businesses struggle to make a profit, which is a core issue for them. Others make a profit but reinvest it all back into the business, which can be a mistake.
• Based on my experience, taking profit out from the business while growing it is beneficial. Being asset rich and cash poor, like I was with my gyms, leads to financial stress.
• Selling a business often doesn't yield the financial freedom expected, with 99% of businesses not selling at all, and others selling for less than expected.
• Entrepreneurs should focus on generating net free cash flow every year, aiming for business growth that pumps out profits rather than mindlessly reinvesting all earnings.
• I suggest growing a business at a reasonable pace instead of pursuing rapid expansion, which increases risk and often neglects net free cash flow.
• Reward yourself for the risks you take by ensuring you withdraw profits regularly, rather than being solely reliant on a big future payday that might not materialize.
• Tracking net free cash flow aligns the company's focus on profitability beyond the basic requirements to run and grow the business.
• For investing, two key metrics to consider are the price to earnings (P/E) ratio and return on capital, as they help in assessing the value and quality of a business.
• In the book "The Little Book That Beats the Market," these metrics are used to find investments that could lead to above-average market returns.
• Businesses often come with inherent operational risks, so it is wise to regularly extract profits as a hedge against unforeseen events.
• To ensure profit-taking, set a minimum account balance for your business, and routinely withdraw any excess as net free cash flow.
• By closely monitoring and taking advantage of net free cash flow, you can achieve financial security and enjoy the journey of entrepreneurship much more.

Video

How To Take Action

I'd suggest starting by tracking your net free cash flow. Remember, net free cash flow is the cash you can take out after reinvesting enough to stay ahead of the competition. If your business is profitable, don't pour all the earnings back in—take some profit out while growing.

Here's how to focus on that:

1. Know the difference between being asset rich and cash poor. You don't want to end up with only physical assets and no liquid cash.
2. Set a target for slow, steady growth that allows for profit extraction, rather than rapid expansion that overlooks your net free cash flow.
3. Regularly withdraw profits. Set a minimum balance for your business account, and take out anything over it as your net free cash flow.
4. Monitor the key investment metrics like price to earnings (P/E) ratio and return on capital. These can help you understand the value and efficiency of any reinvestments.

By doing these, you can make your business more resilient to unexpected events that could put cash flow at risk. Plus, you'll enjoy your entrepreneurship journey with less stress and more financial security. Enjoy the rewards of your hard work regularly—not just at some uncertain, future sale date.

Quotes by Alex Hormozi

"Net free cash flow is the amount of money that an owner of a business can take out of the business after the business reinvests in staying ahead of the competition and maintaining its competitive advantage"

– Alex Hormozi

"I like to make money while I'm growing businesses"

– Alex Hormozi

"99% of businesses don't get sold ever"

– Alex Hormozi

"Net free cash flow is my home base – this is what I care about"

– Alex Hormozi

"You might as well take some money out of the business every month so you know you make money along the way"

– Alex Hormozi

Full Transcript

what's going everyone in this video i'm going to show you the number one mistake um that i made and that i see a lot of entrepreneurs making in terms of how to make money from more money from their business so the number one metric that i track for our businesses is this one and you may not even have heard this one but i think it is the most important and warren buffett agrees with me all right it's net free cash flow all right say it and then imprint it into your minds all right and obviously this depends on what type of business you're running but what net free cash flow is is the amount of money that an owner of a business can take out of the business after the business reinvests in staying ahead of the competition and maintaining its competitive advantage right and so the problem with the vast majority of businesses and or business owners is that what they do is at some level i mean the first problem is that many of them don't make any profit right so that's probably like problem number one and when you say i'm reinvesting the business and the reality is that you're not making a profit you need to be real with yourself that's probably what's happening category two is the type of businesses that are making a profit but then they take that profit and they reinvest it back into the business now i'm not saying that this is necessarily a bad idea i'm saying that for me in my entrepreneurial experience i like to take money out of businesses i like to make money while i'm growing businesses and this comes hard learned because in my first five years when i started my businesses at the time i was starting gyms i had an online fitness coaching business too whenever i would make money from my gym i would open up another location which sucked right um i mean it sounds great and but i was asset rich and cash poor all right and that made a pretty problem that you were suffering from too i had equipment i had leases i had flooring i had signage i had lobbies i had front desks i had glass walls i had all of the things except for money in my bank account and what ended up happening is i actually at after after three four five whatever years it was um when i sold those companies i ended up getting out of them relatively quickly and i took all the money i got from those sales which i would consider like short sales they were kind of garage sales i pretty much sold them as assets rather than as businesses because i wanted to do this new thing which was gym launch um but what ended up happening though is i took all that money and i went into a new venture so gym launch happened after this but there was a little period of time there where i uh did something new with a partner that i thought was gonna be partnered with and i'll just say in short terms it didn't work out and so what ended up happening is i didn't get a ton of money for the gyms that i sold and then all that money disappeared and at that moment i promised myself i'm never making the mistake this mistake again because what ended up happening is that after all those years and all that you know all that time and the money that i had made all of it was gone i was like i've made millions at that point dollars in revenue right and i had i had nothing you know what i mean and so i see this a lot and the thing is is that a lot of us entrepreneurs have this dream that someday we're going to sell the reality is the chips are stacked against you all right 99 of businesses don't get sold ever right and so this idea that we're going to have this mythical exit someday right for most businesses isn't true and of the of the businesses that it is true many of those exits aren't as sexy as they may sound like right like i technically exited those businesses but it wasn't like you know i wasn't set for life right you know what i mean i think it was like multiple it was like 200 grand 300 it wasn't a lot of money um that i made from those i think i sold all in all uh covering partnerships and all that stuff i think i all in got 200 grand i think for selling six locations like it was just not a lot right and if you've been doing this for years then that exit if you've been like i've been doing this at that time i think for four or five years like that's like 40 grand a year right if i had been just ripping cash out of the business and stacking it the whole time i would have had a lot more money than that at that point right and so this is a mistake that i see a lot of entrepreneurs make is that they're not focused on this net free cash flow right they're not thinking how can i take money out of this business every single year how can this business pump out profits while i still continue to grow it and some of that also comes from the expectation of how quickly i want to grow so a lot of times we want to grow really fast for no reason only the arbitrary reasons that we set for ourselves and the expectations of others that we project right but there's really no reason to do it but we end up just growing irresponsibly and then in so doing do it wastefully and expose ourselves to higher risk and more mistakes and in the process also lose the one thing that we get along the way if you do it the right way which is net free cash flow as in like getting paid to grow your business i remember i sat down with some of my employees um probably eight years ago i was actually at the gyms and i think they had said that they wanted to get a raise or something like i can't remember what it was and i was like do you understand the difference between like imagine working for an entire month right working your ass off every hour of the day right and then at the end of the month not only did i not pay you i just cleaned out your savings for working that hard and they're like yeah that would suck and i'm like that happens to me all the time right and so that's the thing is we take on so much risk and you start to get used to the risk because you've just been doing it for such a long time but you have to reward yourself for the risk that you were taking all right now um the reason that i like net free cash flow is that it focuses the entire company on not just making a profit but making a profit in excess of what is required to continue to run and grow the business all right and so um this is the number one stat that i look at this is what i have my financing report on for all of our entities because this is the real real this is owner earnings this is what warren buffett and charlie munger calculate with the companies that they want to buy because they're like we hate companies where we buy them and then we take all the profit and have to reinvest all that money back into the same business right they're like that sucks that's why they said they don't like manufacturing and they don't like a lot of types of companies where you have to have all these capital expenses meaning money expenses that you buy big stuff that you you know depreciate over time they're like that sucks right and so um net free cash flow is the stat that i track and if you're interested at all um i was reading a book recently called uh the little book that beats the market really good book you can read in one sitting really fascinating actually and he posits that there are only two metrics that are really important for tracking for really getting above average returns all right the first is the p e ratio which is the price to earnings ratio and if you think about what warren buffett talks about in terms of buying businesses he says you want to buy good businesses for cheap prices right so the figuring out whether it's a cheap price is going to be the price to earnings ratio how much how much net free cash flow how much how much earnings is this company creating not that those are the same thing but i'm saying generally right um how much how many what's the earnings of this company and what's the price for those earnings all right so this is number one so ideally you want a really low price for really high earnings now the second thing is uh return on capital and so what that means is now imagine a company that has i'll give you two scenarios let's say we've got a company that um you know let's say they make a million dollars in profit and when they reinvest a million dollars in profit into their company uh let's say it's opening locations just for whatever reason right so they open a new location and fro it cost them a million dollars open location and then that location gets them a hundred thousand dollars a year in additional earnings all right that's a 10 return on capital right that's what that means now let's take an alternative scenario let's say that another company um for a million dollars can open 10 locations and each of those locations can do 100 000 a year right that would be a 100 return on capital and so the beauty of these two metrics is the pe the price to earning ratio tells you this is a is the price of the business we're buying this is a cheaper business right the return on capital tells us the quality of the business that we're buying which is how good is this business a great business is a business that can take a small amount of money and generate lots of cash from it right and so by combining these two things finding the companies that have the lowest p e ratio with the highest return on capital you can consistently beat the market that was kind of the premise of the book which actually really interesting they um they used this algorithm that did these two things and they beat the the s p 500 which is basically i want to say impossible it's it's very difficult to do for most people and they beat it for i think like 25 years which is nuts by a big percentage which was crazy the thing is is that the companies that are usually in this bucket are usually companies that are going through issues and so you're basically buying mispriced bets right and half the companies that you buy that that meet these two qualifications end up tanking but the other half that might have had some bad press because of something are disproportionately discounted in pricing and as a result in the future they they outperform uh the price that you're paying for them right and so to to bring the wagon back around here as business owners net free cash flow is my home base this is what i care about this is the money that i get to deposit at the end of every month because tomorrow may never come we may get outlawed our business may be outlawed there may be there may be some horrendous thing that happens that blows your business up you may have to move locations and stop everything that you're doing and you just don't know and so what we are all exposed to that we discount on a regular basis is something called operational risk we are all exposed right and so if you're doing this for one year two year five years solely with the hope that someday you're going to sell well i just want to break the news to you that you have a 99 to 1 chance of not actually succeeding doing that and so you might as well take some money out of out of the business every month so you know you make money along the way and i can promise you having done it both ways taking money out of the business every month is way more fun it's also way less stressful all right because this is gonna be the stuff that allows you to know every month how we're really doing when you always leave it in the business account you always leave it in there you just don't have a feeling for it but you should be able to deposit money in your account this month and be like this is better than last month or this is worse than last month and you got to feel that not just the numbers but literally what you put into your account all right and so i'll give you one easy tactic um that i was working with one of the one of the companies that i have um an equity interest in um let's let's imagine you've got a big bucket of money all right this is your bank account for your business every month you know after a certain amount of months what your projected fixed costs are going to be all right now what i asked this entrepreneur to do uh because he wasn't taking profit out of the business so i was like hey we're going to fix this right now is you need to come up with a line and you say this is our line this is our non-negotiable everything over this we take out every month all right so everything over a hundred grand everything over 500 grand we're going to take out of the business every single month we're going to clear this right all the way down to the bottom and by doing this you hold yourself accountable to this level all right and so to wrap this puppy up if you're not taking profit out of the business i'd highly recommend doing it number one number two if you're not measuring net free cash flow you absolutely should because you're losing out on one of the most important metrics this is what charlie marker looks at this is what warren buffett looks at this is what i look at not that i'm in the same category as those guys but once i switched to this in terms of my finance and reporting it really clarified it for everything just not just for me but also for my team all right and when you're looking at businesses in general if you're thinking about reinvesting in the business make sure that the dollars that you're choosing to reinvest you're getting the best return on capital you possibly can all right so if you're reinvesting the business and you think you're going to get 10 back we might as well just put it in the smp and get that right and not even have to deal with all the mess and that's okay if you make a million bucks a year you make 500 000 a year and you just put it in the s p every single year you're gonna be really really wealthy right and that's okay and so sometimes your wealth doesn't necessarily have to be generated all entirely from your business or from a sale that you someday hope to achieve that may not actually happen okay that's all i got for you so that's my my my moment for the day net free cash flow track it stack it and make sure that you empty your bank account every single month and stack the right account which is your personal bank account lots of love catch you soon bye