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Why your Cashflow should be King:

An investing peer, Johnny, in a recent discussion with me gave the following comment in reference to my post on cashflow…
“I had been wondering if the cash flow analysis we make of companies could also be made of individual investors. I mean, over the past year my portfolio has taken a small writedown, but the cashflow has improved dramatically and I’m looking forward to another year of double-digit improvement here.”
Johnny, having spent years invested heavily in mutual funds, is a recent dividend growth investor convert who has taken the style by storm. He reads, absorbs, dialogues and focuses on companies that pay a dividend, raise that dividend yearly above the rate of annual inflation and have strong underlying fundamentals. What convinced him of pursuing this new strategy after enjoying success in mutual funds for so long? He realized that fees hurt performance and holding the individual companies himself benefits both cashflow & returns. He’s slowly developing a supreme confidence in his investments like another investor who he admires.

Over the past 12-months Johnny has experienced some modest losses in his investment portfolio, on paper, but the cashflow has improved dramatically and he is currently looking forward to another year of double-digit improvements in dividends. While the markets are tanking he eagerly anticipates future dividend increases, opportunities for lowering his ACB by adding to his holdings through DRIPS’s and the chance of previously high-priced dividend stocks coming down to more reasonable levels for new purchases.

Corporate cashflow as I mentioned earlier is no different for a large corporation than an individual’s ability to get paid, pay the bills and consume goods. For an individual investor cashflow provides a multitude of benefits that are often overlooked by analysts, equity managers or financial advisors.

The phrase, “You only make money when you sell” is no different than interpreting the comment “You only lose money when you sell.” On paper, investment losses might be a tough pill to swallow, and should be considered for tax adjustments at year end, but for a long-term investor concentrating on high quality equities who pay stable and increasing dividends a short-term drop in portfolio value isn’t as worrisome if your cashflow continues to is increase. Cashflow analysis by an investor measures the health of a company to conduct its daily activities, but increasing your individual cashflow as an investor puts more money in your pocket and portfolio. When a company raises its dividend it’s indicating to the equity markets that it has excess cashflow, is willing to return value to its shareholders and demonstrates underlying strength in its operations.

Far too often equity investors concentrate on where to look for profits/gains instead of opportunities to increase their cashflow. Dividends provide excellent flexibility to a young investor by putting money in your pocket to provide liquidity for new purchases. While dividends in the contribution stage aren’t a replacement for contributed savings, it provides an often tax-efficient method of receiving/increasing cashflow or stable passive income later in life. If you are an investor with significant RSP/RRIF assets and forced to withdrawal high tax-inefficient amounts by government policy, wouldn’t you prefer some element of tax-efficient income? For an investor worried about the risk of inflation in retirement, many high quality dividend stocks have raised their dividend 2-5x the annual rate of inflation on an annual basis over the past decade. If your intention is to hold those equities for a long period of time, many are just as safe as any other stock purchase you may make and you receive an increasing flow of cash over that time period. While the initial yields may be viewed as low and provide a deterrent, the growth of the dividends over time may have significant effects to both investment returns and your cashflow.

Of course the true value of dividends is that they are tangible, in your hand returns that are paid in cash and leave little/no room for corporations to cook the books through creative accounting methods. For a risk-adverse investor, Johnny reminds you that “Dividends are birds in the hand vs. the expectation of capital gains, which are birds in the bush.”

While a concentrated dividend-oriented style might not be your preferred investment strategy, incorporating some element of cashflow management can provide the opportunity to improve returns and maintain a level of stability to a portfolio awash in the volatility of uncertain market conditions. At times it’s the little and simple things that get overlooked that help make a real difference when investing, right Johnny?

 

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