Cash Is King

It must indeed be far less stressful (and frustrating) to be the CEO of a private company than of a public one. Stock markets are manic-depressive: they may fall in love with certain stocks or sectors while completely neglecting others, sometimes simultaneously! I am not complaining; it is precisely this market madness that creates investment opportunities.

I believe we are currently experiencing such a situation, as certain stocks—particularly those related to AI—are reaching new highs, while many other, more traditional companies are being ignored or left aside.

In these circumstances, it is essential, in my view, to return to the fundamentals of finance: the value of any financial asset is the discounted sum of its cash flows. The principle applies to a farm, a woodlot, an income-producing building, a bond, or a business, whether private or publicly traded.

For a company, what matters is the free cash flows it will generate over its economic life, discounted to today’s value. Free cash flows essentially represent the cash generated by a company’s operations over a year, minus its net investments in fixed assets. These free cash flows are the amounts a company has available to invest in internal growth (such as opening a new plant or investing in R&D), make acquisitions, or return capital to shareholders in the form of dividends or share buybacks. It is these cash flows—far more than net earnings—that matter to a business owner and to the investor.

Here is the classic discounted cash flow formula (Discounted Cash Flow or DCF):

Forecasting a company’s future free cash flows is obviously difficult. This is why it is important to be prudent and conservative in one’s estimates. However, many companies are currently trading at relatively low levels compared to their current free cash flows (over the last 12 months). In such cases, a company may not need to experience strong future growth for its shareholders to achieve attractive returns.

I will give you two examples of companies that we hold in our portfolios and that you are likely familiar with: CGI and Richelieu Hardware. These companies have been generating substantial and growing free cash flows for many years. Here are their current cash flows (over the last 12 months) and the yield of those cash flows relative to their market capitalization:

For CGI, investors fear that AI could disrupt its business model and significantly reduce its cash flows in a few years; this is a possibility.

Currently, there is strong investor enthusiasm for companies operating in the AI sector. I understand this enthusiasm, as AI holds significant growth potential and could create enormous value for society and the economy in the coming years.

As an investor, I must remind myself that long-term value creation is driven by current and future free cash flows. Some companies in the AI space will undoubtedly hit a home run in a few years with substantial free cash flows that justify their massive investments. However, it is difficult to predict which ones, as the economic model of AI is not yet established or predictable.

In the meantime, many companies are generating substantial cash flows, and their shares do not appear expensive relative to those cash flows. In my view, this is where attractive investment opportunities should be sought. As the saying goes: “Cash Is King.”

Philippe Le Blanc, CFA, MBA 
Chief Investment Officer at COTE 100 

COTE 100 owns shares of CGI and Richelieu in certain of its portfolios under management.