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Rupert Hargreaves
Rupert Hargreaves
Articles (779)  | Author's Website |

Lessons From John Malone: Ignore Earnings, It's All About the Cash Flow

A valuable lesson from the cable cowboy

February 11, 2019 | About:

John Malone is primarily known for his Liberty Media empire. He has grown this business from a struggling company that owned just a few television stations into one of the world's largest media conglomerates, spanning everything from Formula 1 racing to home shopping channels and fiber networks in the U.K.

Malone has become fabulously wealthy during the process, generating tens of billions of dollars for his investors at the same time. Indeed, as I have covered before, it is entirely possible he has created more wealth than Warren Buffett (Trades, Portfolio) over his career, although it is difficult to tell the exact figure because of the various different methods of financial engineering and deals Malone has used over the years.

What is Malone's secret? You could say financial engineering, though a focus on cash flow more than anything else has been more important.

Malone's cash flow obsession

When Malone first entered the cable industry, he quickly realized these companies were huge cash flow machines, something many other investors failed to realize. He believed this quality means they are more like real estate companies, generating recurring, predictable cash flows from steady base assets. Here is how he has described this realization in the past:

"The concept that cable television looked more like real estate than it did manufacturing was always obvious, … to me, anyway. And I think the financial markets really didn’t have a model for cable, because the industry was a small, startup industry with no real following. Coming out of that period of the ’70s, the industry needed some model, some metric how the market could value us. We decided out …to go on a cash flow metric very much like real estate. Levered cash flow growth became the mantra out here. A number of our eastern competitors early on were still large industrial companies — Westinghouse, GE, — and they were on an earnings metric."

In some respects, this business model is unique to the cable industry. Malone has become extremely adept at using the tax code to benefit his operations by reinvesting all available profits back into the business.

As tax is levied on profitability rather than cash flow, this strategy allows him to continue growing his businesses without having to hand over a substantial amount of income to the government.

Therefore, cash flow is the best way to evaluate cable businesses. Earnings growth might be an indicator that management is not running the business in the most effective way:

"I used to go to shareholder meetings and someone would ask about earnings, and I’d say, ‘I think you’re in the wrong meeting.’ That’s the wrong metric. In fact, in the cable industry, if you start generating earnings that means you’ve stopped growing and the government is now participating in what otherwise should be your growth metric." 

If this seems simple, that is because it is. It might seem silly to suggest Malone has become a billionaire just by focusing on cash flow, but it seems this is been the main driver behind his success over the years.

His advice for new business managers and existing business managers seems to be: focus on the cash flow and make sure your debt is sustainable. For instance:

"It’s not about earnings, it’s about wealth creation and levered cash-flow growth. Tell them you don’t care about earnings.The first thing you do is make sure you have enough juice to survive and you don’t have any credit issues that are going to bite you in the near term, and that you’ve thought about how you manage your way through those issues."

Replicating Malone's strategy

Another highly successful billionaire that employs a similar strategy if Jeff Bezos.

We all know the Amazon (NASDAQ:AMZN) story, and how this innovative individual grew the company from a small online bookseller to one of the most important companies in the world today, but what you might not realize is how similar Bezos's strategy is to that of Malone.

They both concentrate on cash flow and business reinvestment. Neither of the managers are particularly interested in profitability, they just want cash generation. Bezos explained why that is important:

“Percentage margins are not one of the things we are seeking to optimize. It's the absolute dollar free cash flow per share that you want to maximize, and if you can do that by lowering margins, we would do that. So if you could take the free cash flow, that's something that investors can spend. Investors can't spend percentage margins."

“What matters always is dollar margins: the actual dollar amount. Companies are valued not on their percentage margins, but on how many dollars they actually make, and a multiple of that.”

“When forced to choose between optimizing the appearance of our GAAP accounting and maximizing the present value of future cash flows, we'll take the cash flows." 

So there we go; some simple, easy to follow advice from two of the most successful business managers to have ever lived. Earnings are not particularly important; it is cash flow and what managers do with the cash flow that you should be focusing on as an investor.

Disclosure: The author owns no stocks mentioned.

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About the author:

Rupert Hargreaves
Rupert is a committed value investor and regularly writes and invests following the principles set out by Benjamin Graham. He is the editor and co-owner of Hidden Value Stocks, a quarterly investment newsletter aimed at institutional investors.

Rupert holds qualifications from the Chartered Institute for Securities & Investment and the CFA Society of the UK. He covers everything value investing for ValueWalk and other sites on a freelance basis.

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