This week I parted with one of my best investments, a pair of vending machines. While I never “got rich” off these investments, they did turn candy and soda into cash and coins every week. The maintenance was minimal. I had a great business partner who handled the operations (stocking the machines). While the investment was simple and profits small in dollar terms, the lessons of what make a good business were great.
There are a lot of ratios and data that turn up on financial statements when researching an investment. Whether you are choosing a stock, real estate, or a vending machine, there are some consistent traits to look for. Simplifying it with our vending machine example will hopefully help you to evaluate investments.
Revenues and Profit Margins
We often called our little vending machines our cash machines. They lived in an elementary school with steady traffic of students, sports practices, and diet coke-crazed moms. In other words, very steady revenue streams. The average candy cost about 50 cents, which we were able to sell in the machine for a dollar. This allowed us to double every dollar we invested into candy, soda, and water.
When looking at an investment, it’s important to see if it is making money and how much it is keeping. Revenue history can show a few things. I like to see a company that has been bringing in money for a while. I also look for a pattern of increasing revenues. This usually signifies a growing company.
Once I’ve identified a good history of increasing revenues, it’s important to see how much of that revenue is kept, or its profit margin. A company that makes a million dollars but costs a million and one dollars to operate, cannot last. Sometimes businesses invest in operations which can limit short-term gains but be profitable in the long run. If a business has strong revenues, which translates into growing profit margins or business assets, this may make a good investment.
Free Cash Flow
Our vending machine immediately generated cash. We made an initial investment in the machines and a small investment in the snacks which immediately began returning cash to us. There was never a gap between our outflows and inflows, so the machines were always stocked and in a position to make money. We had a great Free Cash Flow, which is our cash flow minus operating expenses.
The vending machines have very simple operations but make a very important point. There was never any friction between money going out and money coming in. This allowed our investment to run very efficiently, and it was never at risk of shutting down. A business that cannot receive cash fast enough from its sales, runs the risk of not being able to maintain operations and can be symptomatic of a business on the decline.
The saying “Cash is king” becomes relevant when looking at cash flows. An increasing Free Cash Flow is a good sign of future growth and increasing profits. Like rising revenues, an increasing Free Cash Flow can be a healthy sign for a good investment.
Personal Effort and Labor
This last piece takes a step away from financial statements. I had a great business partner who handled the day-to-day operations. This is important because I do not have the time to be there stocking and maintaining the machines.
I hear clients tell me all the time of their interest in buying real estate. For the record, some of my wealthiest clients have done very well with real estate. It can however require a lot of time, skill, and energy. Unless you bring a competitive advantage to this situation, finding a good partner will be vital to making this a successful investment.
Fortunately there are plenty of investments to choose from that do not require your time or energy to manage. Being able to understand a cash flow statement and balance sheet can help you choose strong investments that can be analyzed from a distance on your own time.
The vending machines were the perfect storm of great profits, strong cash flow, and low effort. If every investment worked out this way, investing would be easy. One of the most important lessons in investing is knowing what you own, so being able to interpret the financial statements is vital. Knowing how all of your investments work together is also imperative.
Working with a CERTIFIED FINANCIAL PLANNERTM professional can help you analyze investments and build a complimentary portfolio. We work with many successful people who don’t have the time it takes to manage investments, the interest in constant evaluation, or the ability to pour over financial documents.
There are lots of investments to choose from that may still be great holdings in the long run. It’s important to build a portfolio of diverse and consistent investments. This will create a nice canvas that can be accented by those once in a blue moon vending machine investments.