I’ve always found the standard Cash Flow Statement hard to read especially for big companies. They pack it with so much detail and it’s hardly presented from an investor’s perspective. Most investors I know simply don’t bother with cash flow because it’s so complex.

If you are using the Cash Flow tool in our Investor Database, you may notice that we present it in a different format. From an investor’s perspective, what we want to know is:

• How much cash the business is generating from “earnings”, taking into account working capital movements (debtors, inventory and creditors)
• How much it needs to spend on capital items (eg. plant and equipment)
• How much it is paying shareholders by way of dividends
• How much it is investing (non capex related)
• How much borrowings it is repaying as a result of its cash surplus or incurring as a result of its cash shortfall.

One of our readers mentioned Evergreen Fibreboard last week, so I’ll use Evergreen as an example. Evergreen manufactures building material products and its sales and profits have been increasing for the past few years. Let’s take a look at their cash flow:

Notice that Evergreen’s profits are eaten up by capital spending and unfavourable working capital movements. They have been in expansion mode, possibly building new factories or adding production capacity, and possibly growing sales by extending more credit lines and so on.

The bottom line is that there is hardly any Free Cash Flow from its operations. In fact Evergreen has to borrow money to pay dividends.

But negative Free Cash Flow is not in itself bad.

It could be that the company is investing for the future. If the investment can generate more cash, it has the potential to pay off in the longer run. In a situation such as Evergreen, it is crucial for an investor to keep track of its working capital movements, particularly Receivables and Inventory. If these items keep building up, it shows that the new production capacity is not converting into cash.  This is undesirable over the long term.

Ultimately as investors, we want:
a. More and more dividends; and
b. Our share price to keep going north

Free cash flow is important because it allows a company to pay dividends and to pursue opportunities that create shareholder value. Without cash, you can’t develop new products, invest in acquisitions, pay dividends or reduce debt.

In fact our Cash Flow format ranks shareholders ahead of creditors

Below is the cash flow for IOI Corporation, notice that dividends paid appear just below Free Cash Flow. After deducting dividends, we arrive at “Residual Cash Flow” which is what the company has leftover for repaying loans or doing more fanciful things like acquisitions, share buy back etc.

(Dividends paid to Minority Interest in this case refers mainly to minority shareholders in IOI Properties Bhd, a subsidiary of IOICORP).

Residual Cash Flow
1. If  it is positive - a company can use excess cash to buy back its own shares, make investments and acquisitions.
2. If it is negative – a company has to find a way to cover the shortfall. It may have to sell its investments, issue more shares or borrow more from its lenders.

Cash flow from operations is important. But how a company manages excess cash or covers cash shortfall has a huge bearing on whether shareholder value is created or destroyed.

Recently in my Church Cell I was reminded of how we should always be humble. I’ve never really associated humility with stock market investment but after reflecting on it, I must say it is extremely relevant.

All this while, I’ve been wandering in the dark thinking that I know it all.

The truth is well put by Peter Lynch:

“In this business if you’re good, you’re right six times out of ten. You’re never going to be right nine times out of ten.”

I hear stories of people who suffered the 1997-98 stockmarket crash and never recovered. This is sad indeed.

If you have been in that situation, my heart goes out to you. You probably hate the stock market so much that you vowed never to buy stocks again. If this is so then perhaps I can offer you a fresh perspective.

I’ve lost money on the market before and I know how it feels. It was a humbling experience. For a time I didn’t want to touch the market.

But I’m glad I am now over that phase.

See, the stock market itself isn’t necessarily bad. It’s just a tool in the economy for people to use. What is bad is in our heart and attitudes, in the way we invest. Our motive is to get rich quick so we can satisfy the cravings of our heart. We want that new BMW, Gucci handbag, or that prized property. The bible says:

Guard your heart more than anything else
Because the source of your life flows from it
Proverbs 4:23 (God’s Word – Student Edition)

You know, some of us are fitness fanatics. We jog and run miles and do everything we can to keep our heart in tip-top condition. We know that when the heart stops pumping we die.

In the same way, how many of us actually exercise our spiritual heart? When do we say enough is enough when it comes to money? When do we put our own ego aside and say maybe the other person is right?

Humility means that when we make a mistake, we admit it and rely on the grace of God to move on. The more humble we are, the more of God’s grace we receive in our lives.

Palm Oil
I’ve always liked palm oil. It’s a useful commodity, something that the world needs that we can supply. But when CPO started reaching RM3500 per ton, I started disliking it as an investment proposition. And looking back I was right about this.

Am I saying this to boast? Far from it! When we are right we tend to be overconfident in ourselves. And that is where we make many investment mistakes.

You see the palm oil analysis to me is quite simple… producers can produce at a cash cost of around RM1000 per ton. Basic economics would tell you that there are super normal profits in the industry and supply will increase because everyone wants to make more money, and therefore price will drop. It was only a matter of time. But everyone was bullish. Analysts were screaming Buy at 3000 and when it reached 4000 it was still a Buy. What garbage I thought… to a point where I was scornful of all this palm oil analysis!

I realized that each good call I made caused me to be more confident about myself. And guess what? The obvious happened… I made some bad calls.

Humility would say that everything happens according to God’s timing. We ought NOT to think ourselves more highly than others.

Keep an Open Mind

The smarter you are, the more you think you know. But we are told that knowledge puffs up, while love builds up.

“The man who thinks he knows something does not yet know as he ought to know. But the man who loves God is known by God.”
1 Corinthians 8:3 (NIV)

Humility would say that despite not agreeing with the analysts on palm oil, I should respect their call. In fact my closed mind has both caused me to lose money and kept me from making money on some stocks.

IOI Corporation started at around RM3.00 in the year 2000, before its spectacular run. If we adjusted for bonus issue and share split, I estimate that the recent peak of RM8.60 would equate to an adjusted share price of around RM60 (someone please correct me if I’m wrong). So it has gone up 20 times in the span of 8 years! But my closed mind said at RM5.00 that it could not go up much further. The analysts who were still calling Buy are just plain silly. Of course, I was wrong about that too.

I am not afraid to admit my mistakes to you. I hope it will give you more insight and wisdom and if you are blessed by it, then it would be a cheap price to pay.

(Picture Source: One Year Bible Images)

http://www.horizon.my/investor/profile.php?counter=ioicorp

We note that Net Borrowings has increased from RM903 million to RM3.1 billion. Amounts Due from Jointly-Controlled Entities has jumped up to RM1.5 billion (from RM160 million previously). IOICORP’s explanation is as per below:

Amounts due from jointly controlled entities represent outstanding amounts arising from subsidiaries’ proportionate advances for the acquisition and development of land in Singapore and were related to development expenses and working capital which are unsecured, bear interest at rates ranging from 1.81% to 3.60% (2007 – 3.12%) per annum and are not repayable within the next twelve months.