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“Cash is King” and Other Investment Lessons from Warren Buffet

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04th May, 2020

By Julius Masaba

Last time I left having highlighted to you some of the investment opportunities that are lucrative in economic down turns or crises. I mentioned; capital and money markets, produce trading, transport & logistics, urban vegetable farming and investing in yourself.

But in the past few weeks, I have been getting some messages in my inbox and WhatsApp, mostly about capital markets – investing in stocks or buying shares. Many were asking: how can I invest in stocks/shares, where can I buy them from, are they profitable, how much are the shares, what are the most profitable companies, etc.

This indicated to me that; (1) people are reading what I put out there and, (2) also signifies a knowledge gap since many were interested in investing in stocks, which is okay since not everyone knows everything about all things.

I will be organizing an info-session or mini-training on that after the lockdown, God help us!

The fact is investing in capital markets (and even money markets) requires money, good money. The minimum is UGX100,000 but the fact remains you need big money or start with little and keep raising the limit; make it cumulative.

“Cash is King”. You have heard of that phrase several times, and I will tell you why. If you are the kind that prefers being a serial entrepreneur or investor and one who prefers equity, then this is for you. However, investees and startups looking for equity financing should also pay attention because you might pick something.

Times are hard and businesses are running out of cash – having negative or even zero cash flow positions in this recession whose end is not visible. The future of normal business looks bleak for small startups world over. The big ‘boys’ corporations are not spared either. Businesses are cutting costs; staff salaries, because of low revenues, sales have dwindled. Equity Kenya just announced laying of sixty staff!

I work with and, on a few clients, who need financing badly given the essentialness of the services or products they offer. I also know of a few who have been looking for financing even before the Covid-19 pandemic struck. They are hanging in there.  I also know some who want to sell off their businesses, since 2018.

If you are an investor whose risk appetite is high up there and interested in buying off or investing in existing businesses, this is the best time to do that. But be sure that you can play by the rule – cash is king. When you have cash, you can do anything but ethically. Not bribing hotel staff to allow you jump mandatory Covid-19 quarantine and drive to your homeJ.

Of late, China is and has been buying off whole or just stakes in companies in US, Italy, France even some in Africa. However, some of the acquisitions could be due to unfulfilled loan obligations. It makes the Red Dragon looks like a global loan shark or money lender. The issue is, it has too much cash and cash equivalents, to either buy or lend out.

Take that to an individual level, you will see the possibility am talking about.

Like Warren Buffet of Berkshire Hathaway. In the last article, I left having told you that that I was reading a certain book and Buffet’s letter to the shareholders about the 2019 performance as he compared it to other Standard & Poor (S&P) 500 players.

Buffet and company boosted of more than USD125 billion in cash and cash equivalents, and he was in position to buy off or have more than 50% stake in other bigger but smaller than them companies like MacDonald, Elon Musk’s Tesla, Starbucks, T-Mobile, General Electric, General Motors, etc.

His trick is that he always considers a certain portion of cash kept and untouchable, having promised the shareholders to hold at least USD20 billion in cash equivalents to safeguard against unexpected catastrophe – like this Covid-19; allocating part of the retained earnings for rainy days.

It’s this ability to hold cash that allows you to purchase anything you want when others are struggling. As many are running short of cash, Buffet takes the opportunity to act as a prop by buying stakes in them.

Eventually, he managed to buy stakes in JP Morgan Chase – an investment bank in the US ranked as the largest by S&P 500 with an asset base worth USD2.7 trillion, U.S Bancorp – another big commercial bank in the US, General Motors – the maker of GMC vehicles, parts and also an investor in financial services.

The other is Kroger – one of the biggest US retail and domestic consumer supermarket; compare it to the Uchumis or Shoprites of East Africa. Listed companies of domestic consumables are a big deal. If you’re to buy stocks, target such (banks and utilities) – they will always sell as long as people are consuming and ordering for products.

You will realize that the banking or financial services industry is one of the hottest cakes in any listed stock market given its high profitability. Just look at a few stock markets in East Africa, most listed players are banks and shareholders have high affinity for such stocks. The banking sector also stimulates economic growth, it’s always a sure deal they will turn a profit, unless otherwise.

How does Buffet do it, what does he base on?

I want you to pick a few things from here.

Buffet’s investment appraisal skills are simple and common in the investment/finance field; coupled with his investment acumen and entrepreneurial experience, he becomes something else. Before he invests in any company or acquires it, he mostly bases on these three (3) parameters;

  1. Investees must have a good return on the net tangible equity/capital required in their operations – Return on Investment
  2. Investees must be run by able and honest managers – Corporate governance
  3. Investees or stakes/shares must be available at a ‘sensible price’ – Company or business value

My simple elaboration.

Return on tangible equity or capital (ROTE or ROTC) is the net profit (after interest & tax) as a percentage of the average tangible equity or shareholders’ capital. Tangible equity or capital is net assets or equity less intangible assets like goodwill, etc. It increases the operating profit of the tangible investment (capital) that company management has to generate that profit.

It simply measures how much profit the company earns on every shilling invested in tangible assets like inventory, property, plant, & equipment (PPE). Best if the company deals in machinery and heavy duty equipment like transport vehicles, tankers, haulage trucks, logistics, renting out of construction equipment – canes, graders, etc.

For example, it’s easier to determine the ROTC of an investment of say in a transport business like cab (Uber), taxi or matatu. Let’s assume an existing matatu business needs an investment of UGX50 million to purchase an additional 14-seater van but instead of giving cash, you invest in a new van worth the same amount.

We then call your van equity (tangible capital) in form of an asset added on to their fleet. Assuming the van makes journeys within Kampala going as far as Kiira, Namugongo, etc. and back to Kampala central business district (CBD), it will make at least UGX80,000 to UGX120,000 daily. Let’s take the lowest (UGX80,000); that will be UGX2,000,000 monthly minus two days, and UGX24,000,000 annually.

Then, the ROTC will be 24,000,000 divided by 50,000,000 to give 0.48 (48%). It is a measure of profitability. So, the higher the positive result the more profitable it is to invest in that fella’s taxi business. It’s like ROI. This is one of the criteria you should use before you inject your hard-earned cash into any business, either as an entity or individual.

Corporate governance is management hierarchy, the policies and regulations, procedures by which an organisation is managed. In startups investment, it’s the ‘Team’ section or slide during pitching. Listed companies have to deal with Boards of Directors or Governors and principles like accountability, fairness, transparency and responsibility.

Investors, even in the startup world where structures and internal control, risk policies are not essential, will need to look at your team (co-founding and staff) composition. People invest in people. I will also try to relate and show you how corporate governance affects ‘sensible price’ or value of a company or business.

There is a way corporate governance plays a huge role as far as an investment decision are concerned. Good, profiles managers instil confidence in staff, customers, and of course shareholders. A recent scenario can be seen in the rise in Stanbic Uganda’s share price from UGX24.35 to UGX24.4, a day after Patrick Mweheirwe was announced the new Stanbic Group head in Kenya in March.

The price rose by 0.17%. There is more confidence in highly experienced staff, MDs, CEOs, etc. So, look out for such factors when investing in startups or listed companies or even before acquiring other businesses.

New or reshuffled management could estimate future corporate governance performance by a company the expectations implied by the current price or value of a company with its own expectations calls in its corporate plan like staff restructuring, etc.

If the industry or market expectations appear dull and immodest, management then has the opportunity to relay information or data that enables the market to raise its expectations. Such data analysis can help show the economic link between internal performance or management ability and likely returns to the shareholders or investors.

With ‘sensible price’, Buffet tries to speak in parables. He is simply saying the company’s value (prospective investee or acquisition) should be cheap and in current time of planned purchase. When there is a scarcity of businesses to buy or invest in, don’t buy but hold your cash for some time. Because not many are selling; not many are buying either.

When the price is low (sensible) and in very bad times (like now), everyone is not selling and just a handful are buying; then be among the handful (buy) at ‘sensible prices’, because you have some stacks of cash put away for rainy days or future investment.

Having a good portion for retained earnings is a pre-requisite for buying off or investing in other businesses of your choice or those you have been eyeing but unable to afford, at very low ‘sensible prices’.

There is power in retained earnings. Learn that from Warren Buffet. They are important, but how they are used is critical. They are often leftover funds that are re-invested into the business or used to acquire new businesses through buy offs. They represent a healthy cash flow position or cycle.

At an individual level, assume you earn UGX500,000 net salary, deducting your basics (operating expenses) like rent (UGX150,000), feeding (UGX100,000), transport (UGX150,000) leaves you with UGX100,000 that would be your retained earnings (or even less). The larger the better.

However, in personal finance, that is not advisable or acceptable, ‘retained earnings’ or savings are deducted first before any other basic expenses. So that it’s from your savings where you will be covered in the rainy days and as a source of your business startup capital.

Let me hope that the analogy makes some sense.

What should you do?

Having assets in cash or near cash/liquid form gives you an advantage over your peers in the market or industry, be it as an individual or business. You are able to buy once expensive stuff cheaply in economic downturns. So always keep hard cash and others like cash in the bank, mobile money, debit cards, etc.

NB: This article also appeared on Medium, by the same author. Click here

About the Writer

Julius Masaba is a private investment researcher and business consultant. He’s also the Business Development Lead at Ablestate, https://www.ablestate.org/ and a WordPress writer/blogger on startups, entrepreneurship, business and finance. He loves tech. Visit: https://consultmasaba.com/

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