College mates Ian and Tim recently met up at a coffee shop, when their discussion turned to investing. Here is how their conversation went:

Funny Munnee Comic - Invest like a Pro

Ian started off with the usual, ‘Hey man, what’s up?’

With enthusiasm, Tim replied, ‘The stock market, bro! I’ve just started to do some trading.’

Knowing Tim’s almost non-existent investing habits, Ian was indeed pleasantly surprised. Usually, they would just talk about anything under the sun. Except they have never talked about finance and investments.

‘Wow! That is definitely something new, for both of us!’, Ian responded.

With glee, Tim said, ‘Yeah! It sure is.’

Ian asked, ‘But I’m curious, what exactly got you started on trading?’

Tim then revealed how a colleague of his had made huge gains from stock trading. Tim explained that since he was looking for an honest and legitimate means of boosting his income, stock trading seemed ideal as it could be done on a part-time basis.

Ian nodded. Casually, he asked, ‘So Tim, what kind of stocks are you looking at right now?’

Tim replied, ‘I’m looking at ABC Bhd.’

Ian asked, ‘I see. What does ABC Bhd do? What kind of business does it run, and in what sector?’

Tim replied, ‘I don’t know.’

Ian asked, ‘Err…. Okay. Well, do you know how much of earnings ABC Bhd made last year?’

Tim replied, ‘Come on, bro. You know me. I’m not an accountant. Why would I need to know about ABC Bhd’s finances? I’m interested in ABC Bhd because their stock price went up from RM 0.20 a share to RM 0.50 a share, and I think it can go higher, man! What do you think?’

Ian responded, ‘Tim, from what you have told me, it seems you know very little about ABC Bhd. From my perspective, being absolutely new to stocks with almost no knowledge, don’t you think I would at least want to know:

  1. What business ABC Bhd is involved in?
  2. If ABC Bhd is not a new company, does it have a track record of making profits in the past?
  3. Is cash flowing into ABC Bhd from its business operations?

Tim questioned, ‘Come on Ian, is cash flow really that important? After all, I’m just in it for capital gains!’

Ian remarked, ‘Of course! It is important to look at cash flow even if you are investing for capital gains. Let me ask you this: Do stock prices go up if there are more buyers than sellers in the market?’

Reluctantly, Tim replied, ‘Yes.’

Ian continued, ‘Tim, if that’s the case, what kind of stocks do you think most buyers would want to buy? Stocks that are increasingly profitable? Or, is it stocks that continue to make losses?’

Tim responded, ‘Obviously, the profitable ones.’

Then, Ian asked, ‘How do stocks increase their profits? Don’t they need to invest more to grow and expand their businesses? On research and development? On innovation? On more factory space, etc, etc?

Cutting off Ian, Tim exclaimed, ‘Oh, I get the idea now! That is why cash flow is important. If a company does not generate cash flow from its business operations, then, it may not have the funds to expand its business. Without expanding, the company may not be able to make additional profits. This may influence investors’ decision to buy the shares of the company and thus, affect its share price, right?’

Ian added, ‘Yes! Tim, a company with abundant cash flow would also be capable of paying you dividends. I understand that you are aiming for capital gains, that’s fine. However, you know that we are not the all-controlling, universal masters of the stock market. We will never be able to control which stock goes up in price and which one comes down, ever! So, if the price of the stock you’ve bought just happens to drop, at least (if they have good or future cash flow) you will still receive some dividends from your investment.’

Tim nodded in agreement.

Ian shared, ‘You know, a cash-rich company is usually more resilient and may even withstand a downturn in the stock market. But, a company without cash or facing cash flow problems may need to raise funds through borrowings, issuance of new shares to investors, or even to dispose its assets and inventories at a discount. As you can see, cash is crucial to the survival of a company. After all, isn’t there a saying, ‘Cash is King’?’

Feeling impressed, Tim replied, ‘Wow! I had never realized the importance of cash flow when investing in shares. You have really opened my eyes, especially since my eyes were focused on shares of ABC Bhd!’

Laughing, Ian replied, ‘You are most welcome, bro.’

Tim asked, ‘But, I have another problem. You know that I’m not a financially savvy nor “smart investing” type of guy. Where do you think I should go to start learning about stock investing? You know, the right methods, the proper channels, the right subject matter experts. What should I do?’

Ian replied, ‘I’m glad you asked! Did you know that InvestSmart, an investor empowerment initiative by the Securities Commission Malaysia (SC) organises stock market and unit trust seminars for retail investors? Ian then showed Tim the link to www.investsmartsc.my on his phone.

Fascinated, Ian continued, ‘It says here: The seminars aim to encourage members of the public to take control over their finances so that they can be responsible for their own future and wealth, equip investors with the knowledge, skills and tools needed to exercise good judgement and discretion in making investment decisions and encourage more informed retail participation in the capital market. To find out more, you may log on to www.investsmartsc.my. I’m registering RIGHT NOW!’

This article is sponsored by Securities Commission Malaysia, under its InvestSmart Initiative.

Securities Commission MalaysiaInvestSmart

© Securities Commission Malaysia (SC). Considerable care has been taken to ensure that the information contained here is accurate at the date of publication. However no representation or warranty, express or implied, is made to its accuracy or completeness. The SC therefore accepts no liability for any loss arising, whether direct or indirect, caused by the use of any part of the information provided. The information provided is for educational purposes only and should not be regarded as an offer or a solicitation of an offer for investment or used as a substitute for legal or other professional advice. For enquiries regarding sharing, republishing or redistributing this content please write to: admin@investsmartsc.my.


KCLau
KCLau

Personal finance author and trainer

    1 Response to "Why Cash Flow Matters … Even if You Invest Only for Capital Gains!"

    • John Chan

      Sounds good.

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