If I could summarise my most successful investments in one equation it would look something like this:
Cash + Optionality + Astute Capital Allocation = Compounding Machine
Good businesses generate lots of cash. Great businesses generate tonnes of cash, have lots of capital deployment options and, more often than not, choose the right ones. This leads to higher future cash flows which can be reinvested, creating a virtuous circle.
Focus on the cash
Cash flow is the oxygen that gives companies room to invest. It pays the bills and can be used to fund growth projects.
It is not the same as profit, an accounting metric that can easily be manipulated.
Some businesses are very good at generating cash. Others are terrible at it. Most lie somewhere in between. I try to focus my attention on the first category and largely ignore the other two.
This part of the equation gets the least attention, but is hugely important.
Plenty of businesses generate cash, but they have little choice of what to do with it.
Let me illustrate with an example.
Just Eat is an online takeaway aggregator. Its website and app connect hungry customers with many independent takeaway outlets.
In the past, Just Eat only partnered with restaurants that had their own delivery networks. That arrangement worked brilliantly for Just Eat because delivering food to peoples’ homes is expensive. Just Eat charged a fee on every transaction via its platform, but got others to do the donkey work. The business threw off cash.
Then something changed. Other takeaway aggregators like Deliveroo and Uber started gaining traction. These privately funded companies didn’t seem to worry about trivial matters like cash and returns. This meant they were happy to arrange delivery on behalf of restaurants. Unsurprisingly, the hungry customer sat at home loved this. Now they could get takeaway from pretty much any local restaurant, regardless of whether they deliver.