Simple secrets of a good investor
People often ask what it takes to be a great investor. Many books have been written on the subject but sometimes the best answer can be found with a little old-fashioned common sense.
My own grandfather liked to keep things simple. Among his pearls of wisdom was that most things can be solved with some elbow grease and that there is tremendous value in the lessons of hands-on experience.
This is something that many seem to forget when investing. Not surprisingly, the most common mistakes are the failure to undertake proper due diligence and the search for quick return.
Proper investing requires time and patience. There is a reason why some of the world’s best investors are successful business owners. Building a business takes time, patience, a heck of a lot of effort and learning from hands-on experience.
One of the most important lessons I’ve learned as a business owner is the value of cash flow. A great business generates a lot of cash, which can be used to fuel the continued growth of the business or spun out as dividends to the owners.
When evaluating a potential investment, we find it helpful to look at it as if we were going to literally acquire the company. We spend considerable time reviewing the company’s strategic positioning and its ability to generate strong cash flow. While earnings are important, they can be manipulated, but cash is always cash.
As investors we don’t mind providing cash but with the expectation of some form of a return. There is nothing worse than handing over our cash and then having management come back asking for more without accounting for what it did with the initial investment.
Bull markets tend to mask such events and companies can get away with a lot. Eventually though, the chickens come home to roost.
Consequently, many have seen their share prices more than halved in the past few years compared to higher valuations for those companies that have been more prudent with their shareholder capital.
Finally, after finding a good company one wants to avoid overpaying. Again, it helps to envision actually acquiring the company and determine how long before you get your cash back. For example, we would consider paying five to eight time’s forecast cash flow quite reasonable for a company with strong growth or income profile.
At times, it can be worth paying in excess of this as long as one is confident in the underlying company’s superior growth profile. A great way to factor all of this in is to discount the estimated forward cash flow and compare it to the company’s current share price.
In the end, cash is truly king when evaluating investments. Earnings and financial statements can always be manipulated, but nothing beats strong cash flow.