Epoch chief executive William Priest said accounting ratios such as price to earnings, price to book and reversion to the mean are “complete nonsense” and that investors should instead use a cash flow process.
Mr Priest defines free cash flow as the “cash available for distribution to shareholders after all cash taxes and capital expenditures”.
“If you want to understand how a business works, follow the cash,” said Mr Priest. “If you can’t follow the cash, there’s usually a reason and that’s that they don’t want to tell you how it works.”
Mr Priest said that with a background in accounting, he knows it is possible to “violate any accounting principles and make earnings into anything you want”.
“Accounting is like a bathing suit: what it reveals is interesting but what it conceals is vital,” he said.
He believes this is because there are a lot of assumptions in accounting.
“There is a big difference between cash and earnings,” Mr Priest said. “I never worry about quarterly earnings reports; I worry [about whether there are] good capital allocators and what is happening to final demand in the business.”
Epoch Investment Partners has an alliance with Grant Samuel Funds Management, a funds management firm specialising in the marketing of managed funds to Australian institutional and retail investors.
