You can't spend earnings. At first glance, this probably seems like an odd statement, possibly even incorrect. However, it is not only correct, but an important investing axiom for any type of investor. Let me explain.
Earnings are that which is derived from the exchange of a product, service or other, less associated expenses. Ultimately, it is our desire that earnings are converted to something that can be spent, such as cash. You may be thinking that is just semantics, but is it? In the article "The Most Important Financial Statement", I mentioned that cash flow is what ultimately drives the value of any financial asset, yet there is sometimes a disconnect between earnings and cash.
Through fraud and manipulation an income statement can be made to look quite impressive. There is not a shortage of stories where expenses are moved to the balance sheet as assets in order to artificially inflate earnings. However, a management team does not have to be dishonest for an income statement to misrepresent the company's true financial condition. Given complex accounting rules, a company can generate huge paper gains that may never be converted to cash.
I take great comfort in a company with a strong cash flows and a consistent history of increasing cash dividends. An increasing cash dividend keeps pressure on management to ensure the company is well run. If there are too many missteps, then eventually a dividend will slip. This can be disastrous for a company's stock price.
Earnings can be manufactured, cash can not. Always follow the cash and it just might lead you to a great company.
Full Disclosure: No position in the aforementioned securities. See a list of all my income holdings here.
- 12 Dividend Stocks Delivering The Secret To Success
- 12 Dividend Stocks For A Rainy Day
- 9 High-Yield Managed Distribution Policy Funds
- The Elite Dividend Stocks List
- Dividend Stocks Poised To Beat Inflation
Popular Posts - Last 7 days
We all want to succeed in everything that we do, including investing in the stock market. Though I have no analytical data to back it up, I...
A stock dividend , also known as a "scrip dividend", is a dividend payment made with stock instead of cash. Sometimes when compani...
Each Sunday I highlight any notable articles that I came across over the past week. Though I may not always agree with each of the articles ...
Linked here is a detailed quantitative analysis of Johnson Controls, Inc. (JCI). Below are some highlights from the above linked analysis: ...
Presented below are my dividend stock and ETF/CEF holdings. This is not a recommendation to buy these securities. I have classified some of...
Monday, October 31, 2011 will mark my fourth full year of writing as Dividends4Life . It is hard to believe another year has passed. Like th...
Like many that came before me, I am on a journey to construct a portfolio that will provide me... Dividends 4 Life
Linked here is a detailed quantitative analysis of HCP, Inc. (HCP). Below are some highlights from the above linked analysis: Company Des...
You can’t spend earnings ! At first glance, this seems like an odd statement, possibly even incorrect. However, it is not only correct, but ...
Linked here is a detailed quantitative analysis of Pepsico, Inc. (PEP). Below are some highlights from the above linked analysis: Company...