The Motley Fool

Why cashflow is king for all investments

In my opinion, cashflow is king for all investments.

The true value of an asset is all of the cashflow it’s going to produce, discounted back to today’s value using a discount rate. The discount rate is significantly affected by the interest rate, why is why we’re seeing such high asset prices these days due to record low interest rates.

The point of cashflow is how much actual money is coming back to investors or is re-invested back into the business. It is easier to manipulate the profit statement than the cashflow.

It’s why I’m never going to be attracted to the idea of ‘investing’ in cryptocurrency. There’s no cashflow at all, it’s all purely speculation that someone else will pay more than you did for the digital currency.

Residential property is also very unattractive for cashflow, with gross and net yields extremely low.

Ideally, we want to find businesses at attractive prices for the cash they will generate over many years to come. And that’s quite hard with how low interest rates have been pushed.

Whilst I may miss out on the earlier stages of growth of businesses like Afterpay Touch Group Ltd (ASX: APT) and Uber, I don’t want to invest in businesses that aren’t profitable, or at least aren’t yet cashflow neutral, unless they have a very clear path to profit such as Xero Limited (ASX: XRO) where they have such high gross profit margins it’s only a matter of time before they reach positive cashflow status.

Even if a business is profitable, I want to know how that business is going to give me the cash. Will the business pay a healthy amount of the cashflow out as dividends or distributions each year whilst steadily earnings growing too? Or is there expectation that it will keep re-investing back into itself which will create more value than paying out the cash, like with Berkshire Hathaway? Empire building by CEOs can be very damaging if it goes wrong. 

Foolish takeaway

There was a disconnect between the profit reported and the cashflow being produced at some of the disappointing blow-ups on the ASX that we’ve seen over the past few years, which is why I think cashflow is very important to pay attention to.

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Motley Fool contributor Tristan Harrison has no position in any of the stocks mentioned. The Motley Fool Australia owns shares of AFTERPAY T FPO and Xero. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. This article contains general investment advice only (under AFSL 400691). Authorised by Scott Phillips.

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