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HL Select Funds

Why we like companies with strong cash flow

HL SELECT UK GROWTH SHARES

Why we like companies with strong cash flow

Managers' thoughts

Important information - The value of this fund can still fall so you could get back less than you invested, especially over the short term. The information shown is not personal advice and the information about individual companies represents our view as managers of the fund. It is not a personal recommendation to invest in a particular company. If you are at all unsure of the suitability of an investment for your circumstances please contact us for personal advice. The HL Select Funds are managed by our sister company HL Fund Managers Ltd.
Charlie Huggins

Charlie Huggins (CFA) - Fund Manager

14 November 2016

One of my favourite sayings is: "Revenue is vanity, profit is sanity, but cash is king."

Profit and cash flow are not the same; often companies generate far less cash than profit. Customers can be slow to pay, but suppliers may demand payment upfront; so there is a profit on a sale, but the cash hasn’t come through the door. Or a business has to spend very heavily on new assets just to keep generating the same profit.

We aim to avoid these companies like the plague in our new fund HL Select UK Shares. Instead, we look for those generating cash in spades, ideally from intellectual property such as brands and distribution networks, rather than hard physical assets.

Weak cash flow can leave a business at the mercy of lenders, which can be a toxic situation if the economy takes a turn for the worst. We tend to look for businesses that have little or no debt, which can easily head towards net cash positions on their balance sheets. We believe this gives us the best chance of offering a degree of shelter to investors’ funds when cyclical downturns occur, although of course there are no guarantees, and investors could get back less than they invest.

Strong cash flow gives a company options

Weak cash flow limits a company’s ability to reinvest. Strong cash flow gives a company options. It can choose to invest in extra staff, research and development, or acquisitions. If spent wisely this could boost future cash flows, resulting in a virtuous cycle of growth.

Strongly cash generative companies will tend to generate much more cash than they need, even in the bad times, allowing them to return more to shareholders. Our main focus is upon financial strength and growth potential, but our process naturally leads us to companies that pay growing dividends. We expect special dividends and share buybacks to feature strongly too, although all dividends are variable and not guaranteed.

Focusing on cash flow also gives us more chance of identifying exceptional businesses, which is the bedrock of our investment process. Strong cash generation frequently goes hand in hand with high returns on capital, high margins, recurring revenues and intellectual property; because it is much easier for a business to generate cash if it exhibits these characteristics.

In a nutshell, that is why, we believe, Cash is King. Cash keeps the bankers at bay, and gives companies the power to reinvest; while keeping shareholders happy. It all comes back to investing in businesses that are in charge of their own destiny.

What is HL Select UK Shares?

HL Select UK Shares is a completely new Hargreaves Lansdown Fund. Offering access to a portfolio of exceptional UK shares, chosen and managed by our experts in the convenience of a single fund, with a new level of transparency and insight.

More about HL Select UK Shares

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Important - This article is not advice or a recommendation to buy, sell or hold any investment. No view is given on the present or future value or price of any investment, and investors should form their own view on any proposed investment. This article has not been prepared in accordance with legal requirements designed to promote the independence of investment research and is considered a marketing communication. Non-independent research is not subject to FCA rules prohibiting dealing ahead of research, however HL has put controls in place (including dealing restrictions, physical and information barriers) to manage potential conflicts of interest presented by such dealing. Please see our full non-independent research for more information. Unless otherwise stated performance figures are from Bloomberg and estimates, including prospective yields, are a consensus of analyst forecasts from Bloomberg. They are not a reliable indicator of future performance. Yields are variable and not guaranteed.