The Cashflow Solution process

The philosophy is based on the mistakes people make when forecasting. The fund managers believe stock prices are frequently mis-priced as they tend to reflect the often unreliable and, at times, completely misleading, forecasts of future profitability made by company managers. These understandable errors in profit forecasting seem to play a dominant role in setting investors’ expectations, as investors treat these forecasts as superior and underestimate the risk that they will be wrong.

The fund managers find, in contrast, that historical analysis of company cash flows is a more reliable guide to future profitability and stock price valuation in the medium term. Investors undervalue free cash flow, a fundamental building block of long-term growth, in favour of short-term profit forecasts. Investors’ focus on profit forecasts over fundamental value provides a consistent opportunity to add alpha.

The fund managers focus on the historic cash flows generated and invested by companies to support their forecast profits growth. As forecasts are often unreliable, the scale of cash invested to support forecasts is key.

The fund managers seek to own companies that generate significantly more cash than they need to sustain their planned growth, yet are lowly valued by investors on that measure. They sell short stocks that are expensive, are struggling to generate any cash and are run by management investing heavily for future growth.

To identify companies’ annual cash flow, balance sheet development and valuation efficiently across all equity markets the fund managers have developed a simple screen as a starting point for further qualitative analysis. The investment screen consists of two cash flow ratios that are combined equally to highlight the process characteristics that they seek.

Further information can be found in the Liontrust Cashflow Solution Process documents.

Cashflow Solution Process: Equity Income

Cashflow Solution Process: Long-Only

Cashflow Solution Process: Long/Short

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