It is shocking how few CEOs appear to understand what creates value for a business, fixating on showing strong GAAP earnings, or growing the business top line, or a plethora of other activities that may or may not be value accretive.
The value of a business is simply the net present value of its cash flows. Therefore the cash generative ability of a business is its value. Take this quote from the management of HEICO for example:
“HEICO is not in the aerospace business. We’re in the business of generating cash flow, and that cash flow just happens to come from the aerospace business.”
Understanding this, along with return on invested capital is what separates great managers from poor ones. However, management cannot just say the right things, they must show it at the same time.
I recently listened to Glenn Fogel on the Grit podcast. The interviewer was shocked to here that Fogel is very frugal when it comes to where he stays and how he flies on business travel, and that he holds his management team to the same standards. But this is exactly how great management should act. Travelling humbly while on the businesses dime, not only demonstrates to the team that cost management is important, but also reflects the understanding that the business’s money belongs to the shareholders and that management’s job is to earn a return on that money. Luxury travel does not achieve that and thus should be spared. This is why I like management that has a finance background, like Fogel and like Bezos, because they often understand this better than engineers who are focused on product.
Connections
Investing In A Stock Is Investing In A Business
Link Explanation: The understanding that investing in a stock is investing in a business is the fundamental principle that underlies the management discussion in the current note. Of course the value of a business is its ability to generate cash. Of course return on invested capital is paramount. Of course management that understands this essential. But all of it rests on the fact that a stock simply reflects an ownership stake in a business and nothing else.