The Game with Alex Hormozi - The Metric Warren Buffet Cares Most About and How To Use it to Take Home More Cash | Ep 291

Episode Date: April 15, 2021

Keep the cash flowing! Today, Alex (@AlexHormozi) talks about the number one mistake he says a lot of entrepreneurs make in terms of making more money. He also talks about the number one metric that he uses to track his businesses, and why you should follow this concept. 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.Welcome to The Game w/Alex Hormozi, hosted by entrepreneur, founder, investor, author, public speaker, and content creator Alex Hormozi. On this podcast you’ll hear how to get more customers, make more profit per customer, how to keep them longer, and the many failures and lessons Alex has learned on his path from $100M to $1B in net worth.Timestamps:(0:25) - Alex's top metric: Net Free Cash Flow.(3:20) - Reality: 99% of businesses never get sold.(4:24) - Entrepreneur mistake: Neglecting Net Free Cash Flow.(5:49) - Net Free Cash Flow: Profit exceeding business needs.(9:22) - Regular exposure to discounted risk: Operational Risk.Follow Alex Hormozi’s Socials:LinkedIn | Instagram | Facebook | YouTube | Twitter | Acquisition

Net, free, cash flow, all right, say it and then imprint it into your minds. Welcome to the game where we talk about how to get more customers, how to make more per customer, and how to keep them longer, and the many failures and lessons we have learned along the way. I hope you enjoy and subscribe. What's going, everyone? In this video, I'm going to show you the number one mistake that I made and that I see a lot of entrepreneurs making in terms of how to make more money from their business. So the number one metric that I track for our businesses is this one. may not even 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 reinvest 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, an online fitness coaching business too, whenever I would make money from my gym, I would open up another location, which sucked, right? I mean, it sounds great, but I was asset rich and cash poor, all right?

And that made a problem that you are 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, after three, four, five, whatever years it was, 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 just sold them as assets rather than as businesses because I wanted to do this new thing, which was Jim Launch.

But what ended up happening, though, is I took all that money and I went into a new venture. So Jim Launch happened after this, but there was a little period of time there where I did something new with a partner that I thought I was going to 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 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 and the thing is that a lot 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. You know what I mean? I think it was like multiple, it was like 200, 300, it wasn't a lot of money that I made from those. I think I sold all in all, 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 probably eight years ago. It was actually at the gyms, and I think that 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, working your house 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 um that i look at this is what i have my finance team report on for all of our entities because this is the real real this is owner earnings this is what warren buffett and tarley 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 depreciate over time. They're like, that sucks, right? And so net free cash flow is the stat that I track. And if you were interested at all, I was reading a book recently called The Little Book That Beats the Market, Really good book. You can read in one setting. Really fascinating, actually.

And he posits that there are only two metrics that are really important for tracking, for really getting above average returns. The first is the PE 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 net-free cash flow? How much earnings is this company creating?

Not that those are the same thing, but I'm just saying generally, right? How much, what's the earnings of this company and what's the price for those earnings? All right? Hey guys, love that you're listening to the podcast. If you ever want to have the video version of this, which usually has more effects, more visuals, more graphs, you know, drawn out stuff. Sometimes it can help hit the brain centers in different ways. You can check on my YouTube channel. It's absolutely free.

Go check that out if that's what you are into. And if not, keep enjoying the show. So this is number one. So ideally, you want a really low price for really high earnings. Now, the second thing is 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, you know,

let's say they make a million dollars in profit. And when they reinvest a million dollars in profit into their company, let's say it's opening locations, just for whatever reason, right? So they open a new location, and it costs them a million dollars to open the location, and then that location gets them $100,000 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 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 P.E., the price to earning ratio, tells you this 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. And so by combining these two things, finding the companies that have the lowest PE 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 used this algorithm that did these two things, and they beat the S&P 500, which is basically, I want to say impossible. It's very difficult to do for most people. they beat it for, I think, like 25 years, which is nuts by a big percentage, which was crazy. The thing 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 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 outperform the price that you're paying for them. Right. And so 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 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 one chance of not actually succeeding doing that. And so you might as well take some money 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 going to 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 was better than last month or this was worse than last month. And you've 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 that I was working with one of the companies that I have an equity interest in. Let's imagine you've got a big bucket of money. 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. Now, what I asked this entrepreneur to do, because he wasn't taking profit 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 100 grand, everything over 500 grand, we're going to take out of the business every single one. We're that clear this bitch, 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 of one of the most important metrics.

This is what Charlie Morgan 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, 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, well, you might as well just put it in the S&P 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 going to 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 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 purpose. personal bank account. Lots of love, catch you two. Bye.