The hunt for predictable cash flows

Patrick Poke

Livewire Markets

An investor's job can be boiled down to two primary tasks, explains Warryn Robertson, Portfolio Manager at Lazard. First, to predict what a company's cash flows or earnings will be in the future, and secondly, to work out how much to pay for those earnings. Estimating two unknowns like this is a big challenge for equity investors, so why not make it easier? By investing in businesses with cash flows that can be easily predicted, this reduces uncertainty, and allows them to focus on the other half of the equation.

“If you can find a group of companies that has more predictable earnings, more consistent cash flows, you’re making your job as an investor much easier in terms of arriving at that valuation. That is, in essence, the overriding philosophy that I’ve had throughout my investing career.”

In this week’s episode of The Rules of Investing podcast, we discuss some unique benefits that come from investing in infrastructure equities, how he avoids the dreaded "value trap", and one area of investment he thinks could see significant negative returns in the coming years.

Glossary

This week’s podcast got a bit technical at times, so here is a quick glossary of some of the terms discussed:

  • Discount rate - "the discount rate refers to the interest rate used in discounted cash flow (DCF) analysis to determine the present value of future cash flows"
  • Discounted cash flow - "a valuation method used to estimate the value of an investment based on its future cash flows. DCF analysis attempts to figure out the value of a company today, based on projections of how much money it will generate in the future."
  • Risk-free rate - "the theoretical rate of return of an investment with zero risk. The risk-free rate represents the interest an investor would expect from an absolutely risk-free investment over a specified period of time."
  • Cash flow - "the net amount of cash and cash-equivalents being transferred into and out of a business. At the most fundamental level, a company’s ability to create value for shareholders is determined by its ability to generate positive cash flows, or more specifically, maximize long-term free cash flow."
  • Nominal gross domestic product (GDP) - "gross domestic product evaluated at current market prices. GDP is the monetary value of all the goods and services produced in a country. Nominal differs from real GDP in that it includes changes in prices due to inflation, which reflects the rate of price increases in an economy."
  • Internal rate of return (IRR) - "is a metric used in capital budgeting to estimate the profitability of potential investments. The internal rate of return is a discount rate that makes the net present value (NPV) of all cash flows from a particular project equal to zero. IRR calculations rely on the same formula as NPV does."

All definitions have been sources from the Investopedia dictionary.

Time stamps

  • 1:33 - The challenges of managing multiple different strategies simultaneously
  • 4:42 - What makes Warryn tick as an investor?
  • 7:46 - Some tips and tricks that apply well to both infrastructure and equities
  • 13:45 - Some key differences between investing in infrastructure and equities
  • 17:07 - How would listed infrastructure perform in a recession?
  • 25:13 - An area of heightened risk in infrastructure assets
  • 33:26 - What to sell, when to sell, and how to sell it
  • 40:08 - Sorting the genuine opportunities from the value traps
  • 47:17 - Warryn answers our three favourite questions

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Patrick Poke
Patrick Poke
Managing Editor
Livewire Markets

Patrick was one of Livewire’s first employees, joining in 2015 after nearly a decade working in insurance, superannuation, and retail banking. He is passionate about investing, with a particular interest in Australian small-caps.

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