I ran across a PDF where Charlie Munger explains the important difference between companies that make more money than they know what to do with (cash cows) versus companies that always need cash to maintain growth (cash hogs).
So cash cows are obviously better than hogs. And the best cash cows have some type moat – pricing power, economies of scale – and a great capital allocator. See’s Candy is a good example.
But there are only so many companies with a great moat. An alternative is to focus on the better capital allocators via shareholder yield. Then you know the companies are doing something beneficial with the extra cash – paying dividends, lowering debt, and/or buying back shares.
Anyways, Munger related how Buffett taught the difference between the two:
Warren occasionally teaches that lesson in business schools. He used to show students the records of Thompson Publishing, the newspaper company, and AT&T going way back without identifying the companies. And it turns out, of course, that for 30 years the telephone company was a lousy investment for shareholders because they just kept issuing shares like crazy and throwing more capital into the business. They were able to get higher earnings only by reinvesting enormous amounts of cash. There was never any real cash to distribute to AT&T shareholders. This going way back – before the breakup and before the last few years when they changed it into a different kind of company.
In constrast, Thompson Publishing had all of these little newspapers that just spewed out cash. They basically never had to put any cash back into the business unless they wanted to buy another newspaper. So, of course, the people who owned the stock of Thompson became enormously rich, whereas the people who owned AT&T didn’t. The difference, of course, is that one business grew like crazy without requiring more capital. And the other one grew only by requiring more capital than the business made.
You should seek businesses that drown in money if they just pause for breath…
You can find the full PDF file at Value Investing World (it’s the first link).
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