There are thousands of techniques for investing in stocks. Everyone wants to pick a growth stock and to make millions of dollars and to retire early. Many try, but way too few ever succeed. Investors continue to search for the all-powerful, easy-to-use, indicator that can help them pick a growth stock well ahead of its time, to buy low and sell high. It is seldom possible.
Recently the concept of paying attention to “Cash Flow” has become the buzz of investors and wannabe stock pickers. So, let’s chat about “Cash Flow”. But before you get into cash flow concepts, understand that there is no all-powerful, single indicator that can make you rich. You can’t become an expert stock picker overnight. So, before we get to cash flow discussion, though that is an exciting indicator, let me cover some fundamental notions about the stock market in general.
Investing in stocks is gambling. No other way to say that. You place your bets and hope the “spin of the wheel” brings you a reward. You can lose much more than you invest. It’s best to go to a professional in the business of growing your wealth like a Certified Financial Planner.
Also, picking stocks is a very complicated, time-consuming process. No short cuts available. If you don’t want to work it like a full-time job, 8 to 10 hours daily including weekends, then visit a Certified Financial Planner and let him or her do the time on your behalf.
There are many essentials to weigh when trying to pick the right stocks. Not the least of which is the overall market direction itself. If the major indices like DOW or S&P are moving, up or down or sideways, then likely your stock pick will be caught in the same current and will be dragged along no matter how many prayers you say each night and no matter how much “hopium” you apply. To complicate matters, gigantic stocks like Amazon, Google, Microsoft and a handful of other equally large ones tend to skew the overall direction of the markets. Your smoney invested in a good company with great “cash flow” positions, (see below), may not have a chance to bloom because of the currents created by that handful of monster stocks that often drag your stock along, too.
Another anxiety-provoking influencer may be what is called “black swan events”. Black swans are those events which no one can foresee: wars, explosions, earthquakes, mine implosions, vehicular crashes that may claim the lives of company executives, etc.
Finally, you may have to contend with influencers, big money companies and their super computers. Their power over the entire marketplace may move trillions of dollars in a flash. Quite literally, such impact is referred to as flash trading and high-frequency trading. Thousands of trades hit the board before you can even raise your finger toward the keyboard of your computer. This is called manipulation. It’s no conspiracy. The stock market exists only because there are people trying to influence the sale or purchase of stocks, and, yes, even using super computers, planted news stories and even rumors.
One such manipulative technique is what is called “short selling” that, when there are extremely large short positions, will frighten retail investors, people like you, to sell your stocks at a moment that makes the manipulators the most returns on their own investments.
To summarize my warnings to you: if you are jumping into stocks, be sure you know the risks. Have the patience and courage to learn from your many failures. And, always consult a Certified Financcial Planner or Analyst. Keeping your money safe is not a do-it-yourself project.
Since this article is about cash flow, let’s talk about it, now.
There are 3 TYPES of cash flow:
- CASH FLOW attracts a lot of positive attention because it is believed to be much more difficult to fudge this number compared to other accounting concepts such as net income. When you examine a shareholder report you will find a statement of “Cash Flow” that will list how a company uses its money and where the money originates. That statement shows cash coming in and “flowing” out. Hence “Cash FLOW”. Cash flow is believed to accurately reflect what’s going on in a business. On the other hand, a company can toy with other items reported in the balance sheet and the financial statements such as net income results. To continue to the example further, net income can be “adjusting” by affecting other variables that result in the computation of the net income number such as deferrals, inventories, accounts receivable and accounts payable and on and on. Cash flow is believed to be much purer. It is a picture of the actual cash generated by the business. It is sometimes a bit of a chore to compute cash flow but often it will suffice to use the item stipulated in the “Cash Flow” statement.
- FREE CASH FLOW is slightly better than just cash flow. Think of this as cash flow minus expenses and any investments that are made back into the company. A positive number indicates money left over after meeting all expenses and after management fulfils its strategies to grow the business by reinvesting either into capital equipment or into other potential growth programs. Some confusion to the amateur may arise when “Free Cash Flow” turns negative. This indeed can happen if investments into capital equipment, plant or growth programs is excessively heavy. At that point you have to trust in management and in management’s business model. [Hint: even using “Free cash Flow” may drive you back to a need to know management and its business model.]
- LEVERED CASH FLOW likely is the more useful of the cash flows for a stockholder who is interested in collecting a dividend while money sits in the company’s stock. To be sure a company has enough money after paying obligations to be able to pay dividends and to invest back in the business to create future growth opportunities, study the company’s “Levered Cash Flow”. Generally speaking, Levered Cash Flow is Free Cash Flow MINUS all debts/loans and other obligations on which it has to pay interest charges or otherwise pay to discharge.