In recent weeks turns of events which I will post to you later (due to the fact that there are more twists and turns in these turns of events than a country road and since that road remains incomplete) I have learnt a very important lesson:
A very important lesson: cash, cash, cash, cash, cash, cash, cash.
It’s quite an easy one to remember but exceptionally important just the same. I invest primarily in companies that are investing money in research and development that in future years will given them a distinct advantage over the competition and which should hopefully allow them to become market leaders in that sector by offering the most attractive products. This means that they must forego revenue now in order to earn great revenues at a future date. This sort of investing is ideal, because when revenues are low and re-investments high (and often disguised as costs) it is likely that you will have low profits and a low P/E ratio. However, once the company is, hopefully, successful the profits will flow in, the re-investments will start to get recognised and not only will there be higher profits, but also a higher P/E ratio. This is particularly interesting, because if the P/E ratio say doubled, then if profits were to similarly double, returns would in fact quadruple. This is something I like.
However, there is an additional complexity that is almost an art form… cash flow management. Whether a company is re-investing to boost future revenues or not managing cash flow well is of key importance (particularly in the previous case). This, however, is an issue I have not as far forward in my mind, because I’ve now realised (through my experiences) that cash flow should be the most important issue in your mind. No matter how stunningly great a company is, if you do not believe that their cash flow management is up to scratch don’t invest, because such a company is only ever likely to force itself into a corner before getting taken over by a rival that does have cash. From now on if a company doesn’t treat cash as the precious commodity it is and as I would treat it then I’ll be exceptionally hesitant about investing.
In fact I am starting to wonder whether management really revolves around 3 key issues:
- cash management
- creating a culture in which staff can succeed
- right balance between innovation and profits
Of these cash flow would appear to be the most important because there is no point creating a good culture and innovating ready for the future if that future ceases to exist after the company struggles with cash and either goes out of business or gets taken over by a rival.