Cash Cow definition
The world of investments can be tricky to understand, as confusing jargon is often thrown around by financial advisors, investment companies and stockbrokers. One of these terms is ‘cash cow’, which is considered one of the smartest investments that a company or individual can make, due to the potential for continued, reliable returns without much risk or continued investments. But how do you know which investments fall into cash cow territory? And where exactly does the strange name come from?
What is a cash cow?
‘Cash cow’ is the name for a relatively low-maintenance investment that provides continued returns without the need for much additional capital or even attention. They are usually companies or businesses in a mature, slow-growth industry, often with a large market share, and require little investment beyond the initial costs. Those who invest in cash cows will enjoy healthy, long-term profits without really needing to do anything for them.
The name can also be given to products or assets within a business which provide a steady, reliable source of income and profit for the company, which allow it to invest further in new services, innovations or products. A prime example of this is Apple’s ubiquitous iPhone, which generates incredible income for the company every single year and allows it to reinvest the profits into the development of new technology in other areas of the business.
Cash cows are considered safe investments and can help to provide positive cash flow to boost other businesses in your portfolio or struggling divisions within the same company. However, companies like Microsoft and Apple show the calibre of cash cows, and the initial investment price is often quite steep as many people jostle to invest in companies that they are confident will provide them with healthy returns that exceed the market growth rate. It’s worth speaking to a financial advisor and stock broker to see if there are less costly industries to find your cash cow.
Where does the term come from?
The term cash cow can be traced back to the early 1970s, when management consulting firm Boston Consulting Group came up with its industry-defining ‘growth-share matrix’ or ‘BCG matrix’. The framework was designed to help businesses classify their investment prospects or existing portfolio to identify the potential of each one. It was also created to help investors plan their next steps to ensure that their portfolio continues to offer healthy returns.
The term comes from our past as an agrarian society, as cows were seen as the original safe investment for smart land owners long before the stock market existed. Dairy cows cost a relatively small amount beyond their initial purchase price but have the potential to produce milk throughout their lives, giving the owner a reliable, steady source of income. They can also help to keep other areas of the farm afloat. For example, a farmer may choose to plant a riskier crop one year due to its potentially high profit margins. However, if a disease devastates his fields, he’ll always have the reliable income of his dairy cows to fall back on.
So, if we take the farming metaphor and apply it to the modern world of investments, it’s easy to see why investors choose to bolster their portfolio with cash cows to allow them to take other risks that will provide potentially higher returns.
Why is it important to have cash cows?
Investing your cash is never risk-free and there is always the potential for you to lose money, as well as gain it. However, cash cows are an important part of any savvy investor’s portfolio as they will provide reliable returns in a relatively low-risk way. They can be a great way to generate cash flow for other struggling businesses in your portfolio or to help you invest in riskier ventures without having to stump up the cash yourself. They’ll also continue to provide profits even after you’ve recouped the initial investment, meaning they are a source of long-term income.
Other Types of Investments
The BCG matrix outlines three other kinds of investments: stars, questions marks and dogs (sometimes also called pets). Stars are businesses that command a high market share in high-growth markets or new industries that haven’t yet grown to their full potential. They will often require large amounts of capital and some continued investment beyond the initial amount, but can be successfully turned into exceptionally profitable cash cows if the right strategy is adopted by the business. However, they are riskier than cash cows due to their position in more volatile markets, and the potential for you to make a loss on your initial investment is greater, so they are best invested in alongside stable cash cows that will help you recoup any losses.
Question marks are business or products that have a low market share in a high-growth industry. They’ll need lots of ongoing capital to increase their market share and ensure that they become profitable but can be hugely risky and aren’t the best investments for inexperienced or risk-averse investors looking for a safe return. Question marks do have the potential to become stars and cash cows if the right strategy is adopted by the company but can just as easily become undesirable dogs and should be approached with caution.
Finally, dogs command low market shares in low-growth markets and generate poor cash flow. Often, the best strategy is to remove these companies from a portfolio, which can be done by devesting, liquidating or phasing them out so that they no longer consume resources without providing much in return. Dogs are not wise investment prospects due to their poor potential for generating positive cash flow and should be avoided or removed from an investment portfolio as swiftly as possible.