Investing In Shares

All You Are Ever Buying Is Future Cashflows

When it comes to investing in shares, property, farm land, private businesses or anything the only thing you’re really trying to do is buy $1 of future cash flow for less than a $1 today.

Sounds simple right?

Unfortunately, whilst SIMPLE it is not EASY.

The biggest reason why calculating the future is not easy is because there are presently 7.5 billion people on the planet and every day each of these individuals is making decisions that change the world subtly…

In time, small individual decisions collectively turn into trends. New trends can make BIG differences to existing business models and therefore investment valuation assumptions.

The “future cashflows” of billion dollar “blue chip” companies can go from “certain” one year to “uncertain” the following year as innovation, competition, demographics and politics change the investing landscape.

Think of what digital cameras did to Kodak, Google did to Yellow Pages, blogs did to newspapers or even what a slowing China does to Australia.

film-camera-sales

The same principle applies to property as an investment.

If the cashflow of a property drops (due to a dropping rental demand) then price the market is willing to pay to own that investment usually drops with it.

Here’s Mackay’s (an Australian mining town) and its rental vacancy rates, rental rates and sales prices for the last few years:

mackay-vacancy-rates

 

mackay-rental-rates

 

mackay-sales-prices

So what really determines an asset’s value is the cashflows it accrues to the owner over the long run.

So the first question you should ask before making any investment is; will the goods and services that this asset provides be of value to the world in the future?

The second question you should ask is; can this asset continue to provide its goods or services to the world at its current level of profit?

If the answer is “no” to either question, then the price of the investment doesn’t matter. It’s probably a bad investment.

If the answer is “maybe” to one or both of these questions, then more research is required and the price you pay will need to reflect the perceived future risk.

Most importantly an investment is NOT good value just because its price goes up. Most of the time it’s the exact opposite; a rising price makes an investment LESS valuable.

For example, if you determine a company will produce $10 in cashflow for each of its share holders over its lifetime would you rather buy that future $10 for $9, $8, $7 or $6?

Obviously you want to buy it as cheaply as possible.

And yet most people buy assets whose prices are going up when the only thing you’re ever buying is future cashflow.