Stuck on an Island- FREE CASH FLOW

Everybody remembers the question if you were stuck on an island and had to bring a movie, what would it be? If someone were to ask me if I were stuck on an island and had to bring one financial document, what would it be? In a heartbeat, I would reply the Cash Flow Statement. It incorporates the income statement and the balance sheet together.
The Cash Flow Statement provides the investor with a clear picture of its operating performance in a truly accurate way. The Net Income on the Income Statement could be somewhat manipuulated by using accounting gimmicks. Yet just as important, the Cash Flow statement also supplies the investor with how that newly formed profit is being put to work.
The best companies in the world are not only the ones that generate tons of cash, but they are the companies that generate high returns on that cash. The cash flow statement illustrates whether that cash is being invested back into the company or returned to investors via dividends or share buybacks.
When it comes to determining the true financial health of a company nothing is a subsititute for the balance sheet. However, the cash flow statement does an excellent job of previewing what that balance sheet will look like. A talented investor can usually take an educated guess about the company's financial health by simply looking at the Cash Flow statement. This is because if a company is generating a lot of Cash, then they can fund their expansions internally, without having to access finances externally.
So if for some wierd reason you are stuck on an island and are only allowed one financial statement to make an investment, make sure it is the Cash Flow Statement! You never know, maybe that investment will earn you enough returns to be able to pay for a private plane to find you and fly you back home!

High Margins and Stock Picking

I am of the opinion that a stock with high margins does not make it more valuable then a company with lower margins. Lets assume that company A has margins of 20 percent and company B margins of 10 percent. If both companies double there sales, company A and company B both have identical growth in profit. Margins play a vital role in making an investment decision, but for other reasons then a company simply having high margins.

The best scenario when dealing with margins is that a company is growing there margins. However, it is important to distinguish whether the margin increase is more of a cyclical or fundamental nature. If the growth in margins is coming cyclically, then it is more of a temporary increase because of the business cycle. The optimal choice for margin growth is that it is of a fundamental nature. This is when the higher margins come about from some sort of operational improvement in the business. The reason why the fundamental margin growth makes for a better investment because the increase in margins has more of a sustainability and did not just come from the whim of the business cycle.

I have to stress that if you are dealing with a company that has consistently had high margins, you should look at the company skeptically. Because you could see a reverse in margin growth and of the fundamental nature. One of the first things you learn in Economics 101 is that companies with high margins will not keep them for long because it invites other companies to compete and mimic the product/service. The only way a high margin business is sustainable is if the company has a gigantic moat to protect against competition. Coca Cola for example has such a strong brand name that it would be very difficult for a start up to compete and chip away at margins. However, Abercrombie and Fitch has a much better chance of seeing margin deterioration in the future.

Back Blogging---Stock Market appears fairly valued

The stock market appears at the moment to be fairly valued. However, if the economic recovery appears to be sustainable it could very well go much higher. This current enviornment is great for stock pickers like myself. Over the last year, a monkey could have returned in excess of 50 percent by simply throwing a dart at a random list of stocks. In fact, it was the "junky" companies that rose the highest. These are the companies with horrific balance sheets and murky operating prospects.
A great deal of stocks to me seem to be fairly valued or even over valued by the market. But when you dig deeper there are many bargains throughout many industries. So this is the time when the stock picker really shows his true value.