Joys Of Compounding: The Passionate Pursuit of Lifelong Learning

by Gautam Baid

Cash Flow Analysis Cash flow from operating activity (CFO). The higher the CFO is, the better. Compare the CFO with net profit over the years to see whether the funds are getting stuck in or released from working capital. Capital expenditure (capex). Compare capex with the CFO to see whether the company can fund its capital expenditures from its operating cash flow. Companies that show high sales growth without much capex potentially could be capital-light compounders. Total debt. The lower the debt is, the better. High debt (for nonfinance businesses) signifies living beyond one’s means. Avoid companies that heavily depend on the kindness of strangers. Cash balances. Very high cash levels in companies that do not pay dividends should be viewed with caution. The cash shown on the balance sheet may be fictitious. Free cash flow (FCF). This is the discretionary surplus that can be distributed to reward shareholders. The higher the proportion of FCF out of the CFO, the better. If FCF is negative and the dividend is always funded by debt, then the investor should not take any comfort from a high dividend yield. If a company is not ever able to generate FCF, then it may be the equivalent of a perpetual Ponzi scheme, wherein it simply robs Peter to pay Paul. Remember, intrinsic value is derived from the cash that can be taken out of a business during its lifetime. When a company reports profits but bleeds cash, believe the cash. Always. The most common symptoms of falsified earn...