This week’s screen is one that tries to seek out interesting high-yield shares by looking for companies with strong cash flow. While 'cash is king' is a stock phrase for investors, the reality is that relatively little attention gets paid to cash flows. Company results and the analysis of City professionals centres on earnings numbers, even though these figures are far easier to manipulate than cash. What gives?
The problem with cash flow is that it is often just a bit too 'real' to be an easy mainstay of company analysis. There are many perfectly sensible management actions that can hit cash flow in any single year, such as providing credit to customers to secure high-value orders; the purchase of stock ahead of an expected uptick in demand; or making a large one-off investment that will reap returns over may years, are all potentially sensible actions that can hit cash flow. The profit and loss attempts to smooth things out so cash being used can be seen in context of the benefits (real, expected or imagined) to a company.
However, whenever cash is committed to business activities, even when sensibly intentioned, it nevertheless represents a risk: high-value orders on credit are only good if bills are eventually paid; increasing stock can be ruinous if anticipated demand does not materialise; and big investments can be financially disastrous if returns are lower than expected. More importantly, persistent cash-flow trends can offer significant clues to the real health of a business.