“In light of the naked celebrity photos doing the rounds, I’m going to tell you today how to tell who’s really naked in Silicon Valley and beyond.
We all know the story, the Emperor’s New Clothes… An Emperor who loves to buy new clothes and he hears about a thread that invisible to idiots. He sends his nobles and ministers and they all come back describing how beautiful it is. But when he wears an outfit made from this thread and travels through the town, a child says “look, he’s naked”, to which all the townsfolk agree.
Now there is a similarity and it’s this. We’ve seen technology companies list their shares for the first time and on the first day of trading they’ve done well – people scrambling to buy them – seen as exclusive for those important enough to get access and smart enough to understand the business models. Therefore the shares do well the first day.. but then they take a dive as the reality of the outlook for the company starts to sink in.
So how can we tell which companies are naked and which aren’t?
It comes down to this: Revenue is vanity, profit is sanity, cash flow is reality – cash flow ensures a company is not really naked.
What does this mean?
Revenues are the sales a company is making but really this is just a boast. If the cost of making these sales is high, then they’re not generating much profit. So put this to one side..
Now profit is a more sensible measure of the health of the company since it’s the income the company has generated, after costs are taken into account.
But cash flow which is more protected from ‘creative’ accounting is more tangible and can give more confidence in the outlook for a company.
So – revenue is vanity, profit is sanity, check out the cash flow to see who’s freely naked or not…
Thanks very much.”