Cash flow is what we need to operate. Cash flow pays for food, rent/mortgage, gas, and everything else we need. As one person commented, “you can’t eat net worth”. And he’s right. In fact, his corollary point was that net worth can flutter around based on the state of Mr. Market. Many people will happily point out “cash is king”.
All of these things are quite true. But it’s actually a balancing act. As Jeff Brown has pointed out in many articles, if you focus on growing cash flow, it retards the growth of net worth. Focus on growing net worth, and cash flow will suffer. They are two sides of the same coin.
Both cash flow and net worth need to viewed in their proper light.
- Cash flow is the money you can tap.
- Net worth measures how much cash flow you can generate. The bigger your net worth, the bigger a cash flow you can generate.
To buy Disney stock (or not)
Let me give you an example. Since I took on dividend growth stock investments (not mutual funds) as one of my baskets of passive income, I have been reading a lot of websites with differing viewpoints on stocks. One site I read repeatedly mentions Disney (DIS) as a company that knows how to adapt very well to changes in technology. They have a strong grasp on how to roll out the same top notch movies every time a new way form of technology comes out. Remember buying them on VHS? Then came DVD followed by Blu-Ray. Every time a new way to consume media appears, Disney has their A-game on, and is ready to re-sell you the same movie you’ve been watching for twenty years.
I have a strong attachment to Disney. I love their movies. But that is not all. My wife works part time for Disney. We travel periodically to our vacation home outside of Orlando and take the kids to Disney World. We even took them to trick-or-treat earlier this month. You want to talk about a place that appears to have suffered no recession in the past five years? Disney World is it. I’ve been there for the past five years, and everyday, the place is packed. So I have a strong desire to buy their stock.
But I won’t. Know why? Their dividend rate is 1.1% and they only pay once-a-year. Compare that with Vanguard Natural Resources (VNR), the company you probably have never heard of outside this blog. They’re dividend rate is 9% and they pay on a monthly basis with a tax deferred basis.
How you can beat a 9% paying stock with one that pays 1.1%
On the surface, it would appear that Vanguard beats the pants off Disney, but guess what. If you focus on cash flow you can make Disney beat Vanguard every time. You simply buy ten times as much Disney stock, and your cash flow will exceed that of Vanguard! Disney is solid. I’m sure they’ll continue to stay in business for decades to come. That $10 billion company certainly isn’t “mickey mouse” when it comes to making money.
I’m sure you realize my suggestion at buying 10x DIS is ridiculous. But why? Because if Vanguard is doing that well, why not simply buy ten times more Vanguard? I hope this scenario seems simple to you. The trick is, people don’t recognize that it appears in many other places.
For example, people will buy real estate deals in California and put down high amounts of capital to make it “cash flow positive”. That is the same thing as buying lots of low yielding stock to make it flow lots of cash. They don’t realize they are killing their potential to grow their net worth because they are focused on one thing: cash flow!
If you take your capital to other places, like Texas, you can find real estate deals where you might get the same amount of rent for much less capital input. In essence, if you seek the right market, you can get a better yield.
So always look at both and make sure your total net worth is growing at a suitable level with tolerable risk.