There’s nothing I like more than talking about investing.
And working for The Motley Fool, I’m often asked for an opinion on various shares.
“What do you think of X?“
“What should I do now with Y?“
“Have you looked at Z?“
I can’t say I know every single thing about every single share, but I do try my best to give a fair verdict…
…and it’s funny how the same shares crop up in different discussions.
“So Maynard, what do you reckon about…?“
I must admit, I’ve had a few awkward conversations in the last week or two about a certain company. (Even an old next-door-neighbour of mine (Hi Vic!) raised the exact same name to me last year.)
The company in question is Globo (LSE: GBO), a £190m software company that’s traded on AIM.
Now I’m guessing most of you will not have heard of this share, but don’t switch off just yet…
…because I’m hopeful you’ll learn something about a small-cap that has attracted quite a following among a few private investors.
Sales up three-fold and profits up nine-fold…and on a single-digit P/E
You’ll understand the interest in Globo when you see its headline track record — it’s quite impressive.
Here’s an extract from the firm’s 2013 annual report, which shows sales more than tripling to €71m and profits more than nonupling to €27m during the last five years:
And yet… that super growth history does not appear to be reflected in the share price. Indeed, at 51p, the trailing P/E is in single digits.
As such, the low P/E and super growth rate — alongside a mega-high operating margin and cash in the bank — means Globo is flashing up on all sorts of stock-screeners as a possible cheap, top-quality stock.
But as with any share investment — especially small-caps — you do have to look beyond the headline stats to ensure there aren’t any worries lurking beneath the surface.
And with Globo, the issues (as I seem them) are raised clearly within the group’s cash flow statements.
You see, the true test of any business is the amount of cash it produces, and I am afraid to say Globo has not produced that much…
Which made for those awkward conversations with the Globo shareholders I’ve met of late…
The important numbers are in the red boxes
Rest assured, I will try not to bore you silly with an in-depth lesson on company accounting.
But I do have to show you two bookkeeping notes extracted from Globo’s annual reports to explain what’s going on and why I’m wary of the share.
Both extracts reconcile Globo’s reported accounting profits to the amount of cash generated by the group’s operations.
The headline profit before tax figures are at the top of each extract, with various numbers then added or subtracted to give us the cash flow sums at the bottom.
I’ve highlighted the important entries in the red boxes. These numbers are called working capital movements, which essentially reflect the cash paid to suppliers, the cash collected from customers and the cash used to buy in goods to then sell on.
These entries are significant because they can alert you to potential trading trouble.
You see, in my experience, stock going unsold, customers not paying and suppliers demanding earlier payments tend to signal problems ahead…
…and such movements are shown by large negative numbers in the cash flow statement.
Something does not feel right in the accounts
Here’s why I’m wary of Globo:
Added up, the profit before tax figures for all four years to arrive at almost €62 million.
However, all the figures in the red boxes added up come to about minus €50 million.
So just think about that.
Reported profits of almost €62m, of which a mighty €50m has been absorbed into working capital rather than flow through the business as free cash…
…no wonder Globo does not pay a dividend and no wonder it has raised €65m from shareholders since 2010 to help fund its growth ambitions.
The upshot for me?
Something does not feel right in the cash flow department. Far too much money has been absorbed into working capital, which leads me to believe reported earnings are somewhat flattering the underlying business performance.
I would rather be safe than sorry and I would not invest
To be fair to Globo, the company has published additional information about its working capital movements. Here’s an extract of what was issued and which explains the long wait for cash from customers:
However, I am not entirely convinced.
The full text from the additional information can be accessed on Globo’s website, as can the group’s annual reports — so you can see all the facts and figures for yourself and make your own judgement.
For me at least, I much prefer to concentrate on shares where there are fewer questions about cash flow and less chance of things going wrong. To be clear, I would rather be safe than sorry and so would not invest in Globo.
Nonetheless I will continue to talk about this and other shares, even if the conversations can become awkward!
Right now, this ‘screaming BUY’ stock is trading at a steep discount from its IPO price, but it looks like the sky is the limit in the years ahead.
Because this North American company is the clear leader in its field which is estimated to be worth US$261 BILLION by 2025.
The Motley Fool UK analyst team has just published a comprehensive report that shows you exactly why we believe it has so much upside potential.
But I warn you, you’ll need to act quickly, given how fast this ‘Monster IPO’ is already moving.
Maynard does not own any shares mentioned in this article.