When investing in a company, it’s important to remember that you aren’t only buying a stock – you’re ultimately buying that company’s future earnings stream. In turn, how much of that company’s reported earnings (Net Income) is converted to cash, determines what can be reinvested to fuel growth. This is what we call free cash flow conversion – which is a measure of earnings quality. To illustrate this idea, we compare Mr. Price with Foschini. The more cash is generated for every rand of reported earnings, the higher the quality of that company’s earnings is, meaning the company is better equipped to grow returns and compound investor wealth.
Broekhuysen has written a fabulous piece on explaining what you are actually buying when buying a share/ stock and why one would be more attractive than the other.