Businesses are faced with many difficult choices but one of the toughest is what to do with the cash flows the business generates. Do you re-invest in the business to grow more, or take cash flows out and pay the owners (via dividends, salaries, etc.).
Public companies feel this pressure immensely from shareholders who are clamoring for dividends, stock and buybacks to try to increase their returns.
Lost in this noise though is a simple question the owner must answer herself: Can I earn more money re-investing in the business than I can earn with it outside of the company?
This question is much easier answered for private businesses. The owner has a pretty clear view on what types of re-investment opportunities they would make and a decent view of how those opportunities may pan out.
It’s much harder for investors in public companies because the companies. The companies are bigger, more complex and you don’t run the company so access to information is significantly impaired.
For those of you who invest in stocks, this is a critical point that we discussed in a prior note. What is the return on invested capital (ROIC)? In other words, how much is the business going to make on this incremental capital invested?
If you owned the business and you couldn’t reasonably determine what your return was going to be on a planned investment you would almost always skip it. Remember, don’t treat common stocks any differently than if you owned the entire business.
If management doesn’t do a clear job of explaining the return on their investments, there is a reason for this. They don’t want you to know! Good businesses are clear on their returns, bad businesses hide behind adjusted earnings and opaque statements. Just skip those ones. As my mom used to tell me after breaking up with a girl in junior high, “there are tons of fish in the sea.”
All the best,
Your Fortis Capital Management Team