Why do stock investors read a stock’s cash flow statements before investing?
This is because cash flow statements of a stock tell us if the company has strong cash flow management. This is important because if a company has successfully generated positive cash flows from its business operations consistently, it would be able to either reinvest these cash flows back into expanding and growing the business continually and to pay out dividends to its shareholders regularly, thus, serve as a vital source of passive income to them.
The question is: ‘How do I read a stock’s cash flow statements?’. So, let me start by presenting a snapshot of a cash flow statement of Sheng Siong Group Ltd, an operator of chains of grocery stores and supermarkets listed in Singapore.
In this article, I’ll share 4 key things to take note of in a cash flow statement of a company so that you have an easier time interpreting it. They are as follows:
#1: Cash Flows from Operating Activities
This refers to both cash in and cash out arising from its business activities. They include cash collected from customers to cash paid out to all of its suppliers, its employees, its distributors and income tax in a given period of time. For annual reports, the period of time often refers to 12 months.
To me, the most important figure shall be the final item, which is the cash flows from operating activities as highlighted in orange below. Personally, I will prefer to invest in stocks where the orange is continuously positive and growing in the last 10 years.
Let’s take a look at 2019. In Sheng Siong’s case, it has made RM 117.3 million in cash flows from operating activities. Out of which, the management can decide on how best to use it to maximise the wealth of its shareholders and thus, shall lead us to:
#2: Cash Flows Used in Investing Activities
This refers to cash in and cash out from all of the stock’s investing activities. For instance, they include cash invested (out) to buy property, plant and equipment (CAPEX), buy shares of new businesses (could be subsidiaries, associates and JV companies), investment properties, plantation estates … etc for the purpose of increasing its sales and profits in the future.
Whereas, cash in from investing activities are received either in income that are derived from its investments such as interest and dividend income or proceeds from its disposal of property, plant and equipment, businesses, investment real estate, plantation estates … etc.
Let’s take a look at Sheng Siong. From its cash flow statement, the company has spent on property, plant and equipment (CAPEX) only. Thus, I’ll calculate its net amount spent on CAPEX by minusing the amount received from its disposal off its property, plant and equipment (highlighted in yellow) from its amount spent on purchasing its property, plant and equipment (highlighted in green).
In 2019, the net amount spent is S$ 53.520 million (S$ 53.611 million – S$ 0.091 million).
#3: Cash Flows Used in Financing Activities
This refers to cash in and cash out from all of the stock’s financing activities. For instance, cash received in this section would refer to cash collected from having secured funds from equities (investors) and debt via borrowings. Whereas, cash out refers to cash paid to buy back shares from its shareholders, dividends paid to shareholders, and debt repayments to its borrowers.
From Sheng Siong’s cash flow statement, I found that it paid out S$ 52.6 million in dividends to its shareholders as highlighted in light blue. It is the biggest item within this segment of its cash flow statement and I’ll prefer a stock that has an awesome track record of growth in its dividend payouts for the last 10 years for I’m an investor who intends to invest for growing dividends.
#4: Cash and Cash Equivalent at End of the Year
This refers to its final cash balance as at 31 December 2019, the closing date of Sheng Siong’s accounts. It is calculated by the following formula:
This means, on 1 January 2019, it had S$ 87.2 million in cash balance. Then, for the year 2019, Sheng Siong had incurred net cash outflow of S$ 10.8 million for the amount spent on investing activities and financing activities have exceeded the amount brought in from its operating activities. As such, its cash balance as at 31 December 2019 has been reduced to US$ 76.4 million.
In a glance, for the case of Sheng Siong, I found that it has split its operating cash flows where it used almost half on it on CAPEX and almost the half of it on dividend payouts. As such, it strikes a balance between reinvesting operating cash flows for future growth and rewarding shareholders with dividend payouts in 2019.
The above article is meant to introduce the basics of reading and interpreting a statement of cash flows. Mastering the basics is helpful to stock investors as they can use the above information to identify good stocks that possess strong cash flow management and separate them from bad stocks that do not. Hence, in summary: