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Something new

Understanding the quality and nature of a company's cash flows can be a powerful investing tool in your hands

Something new

The cover story of this issue of 'Wealth Insight' breaks from our normal pattern. It is an especially insightful article written by Saurabh Mukherjea, one of our regular contributors, that we have 'promoted' to the position of a cover story. Mr Mukherjea is part of the Investments team at Marcellus Investment Managers, a Mumbai-based portfolio manager and investment advisor.

The reason for this special cover story? There are more than one. One, I'd like to draw the attention of all of our readers to this story and make sure that every one of them reads it. That's because it's a compact tutorial on an aspect of equity analysis that all investors should be aware of, even if they do not practise it themselves. Two, there's a deeper significance to considering cash-flow quality as a major input into investment decisions. It forces you to look into the most important aspects of the business, the ones that will actually determine whether a company will sustainably be an investment-worthy vehicle for your investments.

In recent times, there has been a lot of excitement about stock investing. Much of this excitement has been generated by the Zomato IPO. Moreover, the initial success of the Zomato IPO has raised expectations that other internet companies will soon follow with their own IPOs. This massive amount of noise around this type of stock is unfortunate. As our readers would know very well, I am deeply sceptical of the IPOs of such companies. When I say such companies, I mean all those businesses whose IPOs are being evaluated on unproven projections instead of actual feet-on-the-ground money being generated from the business.

When you read our cover story, take a close look at the companies that are being discussed, the examples of the kind of cash-flow quality and sustainability that Mr Mukherjea is discussing. There's a big-cap headline name like Asian Paints that everyone knows to be an exceptional business. There are also other names that are less known but which discerning equity investors have long understood to be quite investment worthy. On the other side of the fence, we have some standard examples of companies that are known to be struggling businesses in terms of the quality of their financials, though not in size.

So, for most of us, there are no real surprises in the identities of these companies. What then, you might wonder, is the point of all this? The answer is very simple: confidence. It's one thing to know that these are good stocks by reputation, history and a superficial examination of their financials. It's quite another to have a deeper understanding of why they are in that category. Much more importantly, a detailed article like this is an educational endeavour. The idea is not that you'll make a great investment portfolio by these examples, but that you will learn about an analytical tool that will stand you in good stead while evaluating dozens of other companies, and as a filter that will help you pick out investment-worthy stocks that you may not have noticed otherwise.

The contrast with the Zomato-type company could not be more stark or more educational. As you would notice, the point is not that they evaluate poorly under this kind of a framework, but that they cannot be evaluated at all! Read the article carefully and you will understand.