Cash

Recently, found myself looking for companies where valuations were distressed enough for me to take a second look. However, in the midst of looking at them, I realised that I might have been straying away from good businesses and looking at valuations only. However compelling, one should always make it a point to buy only when the companies are looking at, and selling for a song. Shall treat this as a reminder, keeping true to my resolve.

Thinking about the nature of some businesses recently since the start of the week, and how they can bring in the cash for the company. Realised that it might be wise to steer clear of companies which generally depend on contracts for their businesses. Firstly, contract bidding is something which might result in inconsistent margins. Secondly, and probably the most important point, is that cash doesn't come in until after stages. Talked about KingsmenC some time back, but realised that they lie in this 2nd category. After awarding of contracts, they start their work. But payment is received only after certain stages of the project are completed. Now, this only means that the cash has to be invested first, i.e. u can be working for the entire year and only see ur money coming in at the end of the year. How's that for cash? High profits with low cash received, mostly in accounts receivables, Enron-style. During times when contracts keep coming in, the cash might keep coming in too. But when contracts dry up, u're faced with a dearth of cash. Profitable? Might be, but this lack of cash visibility might keep some investors like myself away. It's unlike the kind of business where you immediately see your cash coming in(e.g. I don't think you buy your shirts on contract, but that's just only one example). So, these companies might have high leverage so as to continue on their projects first. When contracts dry up, debts still have to be repaid.

Let's take this simple analogy. Today, I just made some "money" on the markets, because the prices have risen(akin to winning of contracts). Now, if one does not sell away the shares, the "money" is still in the markets(akin to profits in accounts receivables), although the reason and whether you should sell or not is another issue for another day. So, if you "earn profits" in the markets in this way, your profits are techinically not yours, you can't take the money out to invest in other shares to earn more money(akin to lack of cash visibility to reinvest), or repay your housing loan(akin to the business not having the profits in cash to repay debt). What's more, your profits might not remain profits anymore as the price might drop below cost anytime(akin to customers defaulting on payment). Hope this helps.

Now then, what's the way to avoid this happening? Sadly, most of the time, that happens to be the nature of the business, there isn't much that you can do about it. If you can understand and handle it, stay vested. If not, you might want to steer clear.

Anyhow, shall only update more frequently and writing up more in one week's time after everything at hand now is over. Shall look at some property companies if possible and talk about them. Seems like property companies do fall in the abovementioned category, but there are some exceptions. Would really love to hear comments regarding this;)