The purpose of enterprise is to make money. Cash is real money, and a business that doesn’t generate enough of it is not a worthwhile one to be in. Accounting practices today require profit & loss accounts of companies to be presented on accrual basis, or, simply put, business billed and expenses incurred during the period of the statement (quarterly or annual) are accounted for, irrespective of when the money against these is received or paid.

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But the real fruit of the business is the cash generated. Why this is so, is because many a times sales may occur, but the payment may not get realized at all, get partially realized or may get realized with a long lag. Any such outcome puts pressure on the business and may require funding interim expenses through working capital loans that up costs and create debt obligations.

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A healthy business is one where cash against sales is realized in a reasonable period, the inventory rotation is high and suppliers get paid on time, but after offering enough credit period to bridge the sales cycle. While assessing the operating health requires a detailed study of the financial statements of a business over time as well as those of peers, one indicator that can be used to gauge the conversion of income into cash is the operating cash flow to operating profit (or Earnings before Interest, Depreciation and Tax – EBIDTA) ratio.

What the above ratio helps you assess is how much of the operating profit is translating into real cash. And while this number will vary with the nature of business, one should be slightly wary of companies that don’t realize even half their operating profit in cash.

THE CASH GENERATORS

We ran data on companies listed on the NSE (some recent listings are excluded as there wasn’t enough historical data available) to identify companies that had a healthy track record of cash generation (well above 50% of operating cash to EBIDTA) and were also free cash flow positive (means the companies were able to fund regular capex from cash generated and still have some to spare).

What we ended up with was a long list of prominent companies. We then sorted these on operating cash flow to market capitalization basis (using numbers for the last concluded fiscal) or cash flow yield basis and picked out those offering a yield of over 5%. And guess what? We ended up with a bunch of well recognized names, many of them “A” listers, and mostly real economy companies—likely because the IT services pack has already seen a good run after the earlier sell-off.

Here’s a shortlist..

It pays to note here that the above shortlist is of companies based on historical cash flows, not future growth, and hence should not be construed as a recommendation. Any decision to invest must take into account several other aspects as well. The limited takeaway from the above analysis is that there are high cash generating companies available at attractive valuations, based on cash yield, today.

THE LOW YIELD PACK

As a part of the data analysis we also found a bunch of prominent stocks that are trading at low cash yields, suggesting they may be pricey and vulnerable in a tough market. But before jumping to conclusions, it pays to reiterate that this study is based on historical data, so it’s like looking at the rear view mirror and not through the front windshield. While investing one must consider future prospects besides tracking past performance. A smart investor doesn’t look for growth or value, she looks for a fine balance of both.

What’s more many of the digital businesses that are not high cash generating (or rather, high cash burning) today, could actually turn generators tomorrow. So, do your homework before taking any decision.

SHOW ME THE MONEY

Given that the purpose of business is to generate profit, and a real one (read cash), investors should be doubly careful of businesses that generate precious little. So, the next time you find a business showing stupendous profit growth, take a closer look to see if the business is generating an equally strong growth in cash. If not, that could be trouble.

Put your money only where you see money coming in. Happy investing!

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(Edited by : Aditi Gautam)

First Published:Dec 19, 2021 11:39 AM IST