At the end of the day, investing is about cash flow. Prices will go up and down in the short term for all kinds of reason. A pure bet on price action is speculation. In the long term, a business will increase its value by increasing the amount of cash it generates. Then investing should be allocating capital to businesses that I think will generate more cash in the future than it does today. 

That would mean, my decision to allocate capital relies on the capital allocating abilities of the business itself. Now, a business that can grow 20%, 30%, even 40% a year without having to spend any additional dollar would be amazing. But most businesses aren’t like that. Even the ones that appear to be like that are not. 

Some may say Google’s built its search business once and it doesn’t have to do anything to it. But we know it hires more engineers every day and they have teams dedicated to the product. We know people want raises and higher bonuses with better performance. Companies like Google have to reinvest the cash flow it generated into people who won’t just maintain their products but make it better. 

Still, let’s say a company like Google didn’t need to reinvest its cash. What should it do? Well, assuming I owned a business of my own like Google, what would I do with the cash? Well, if there is no use for the cash (i.e. not reinvesting to grow the business because it doesn’t need to) then I would pull the money out. I would pay myself a fat dividend with all the cash that’s generated. 

What else could I do? That is, unless I thought there was another avenue to use that cash somewhere. It’s Finance 101. Companies that can’t use the cash for any growth pay out dividends. That’s one use of cash. But the company must find a place for the cash. 

That means any investment into a business today is predicated on a belief the company will allocate current cash somewhere else to increase cash flow in the future. I mean, there are other reasons why people invest….but I would argue any form of intelligent investing requires the proper allocation of capital by management. When I say ‘proper’ I’m referring to redeploying the cash generated into other areas to generate further growth of cash flows. Without that, the value of the business will cease to increase. Then it would cease to be a good investment. 

A company like Google could redeploy capital by hiring more engineers. Every person hired is an investment on the future of the business. Poor hiring will result in the destruction of the cash that was generated. 

Let’s say my opportunity cost was a 20% return on cash—an hypothetical example. That’s how much I could generate with cash my investments paid out to me in dividends from a successful year of operations. For my investments to retain that cash. I would expect them to redeploy that capital in opportunities that would generate higher rates of return than my opportunity cost of 20%. If not, that would be value destructive for me. 

So what does it mean when I see a company hold $30b or $100b of cash on their balance sheet? Well, it means the business is generating less than 5% returns on my cash. The cash I would find a better use for if they paid it out to me. 

Ah, but some may retain them for a rainy day. That would be considered prudent and such cash amounts should be considered the cost of doing business. If that was the case, then so be it. But what if the company retains 2x or even 4x the amount it costs to operate the business? What if they keep all that cash even after deploying a chink of it to reinvestment opportunities? 

Then, the cash generated from this business isn’t as valuable as the cash generated by a business that finds ways to reinvest every dime of it into opportunities that provide greater returns. With that, not all cash flows are equal. As important to the cash generated by the business is its opportunity to reinvest that capital—not to mention how rational they will be with their capital allocation. 

This makes me pause on some of the monopolies I see today. What happens to these businesses that can’t find any further avenues for growth? What happens to companies that are considered so big that they aren’t allowed to acquire other businesses? What happens when they can’t just hire the world to work for them? What happens when the management of these businesses decide to not use any of the cash generated and let it pile on the balance sheet? 

The business might be so great that it can still generate greater growth in cash flows by only deploying a fraction of the cash it generated. But is that the opportunity I want to invest in? These are all considerations I need to ask myself when I look at a business’s cash flows.