The share prices of Altium Limited (ASX: ALU) and Netwealth Group Ltd (ASX: NWL) have tapered off since the start of the year. However, I still think these two ASX growth shares could be high-quality long-term holds.
Altium and Netwealth have performed quite well over recent years. I think this is mainly attributed to their ability to continually generate rising free cash flow.
Let’s dig into these companies and find out why free cash flow is so important.
Altium share price
Altium develops and sells computer software for the design of electronic products like circuit boards. It’s essentially a tool for electronic product designers.
Altium doesn’t have crash-hot gross margins, wavering between 48% to 50% over the last five financial year ends. However, it doesn’t incur significant operating expenses due to its relatively capital-light business model.
As a result, Altium has been able to consistently generate free cash flow.
Free cash flow enables businesses to reinvest capital into their existing product or service. In the case of Altium, it has been able to develop its latest weapon, Altium 365.
Altium 365 is a cloud-based platform that allows multiple users to collaboratively work on a single project in real-time.
Netwealth share price
Netwealth provides a wealth management platform to the financial services sector e.g. managed funds, superannuation funds etc.
Whilst Netwealth doesn’t generate as much revenue as Altium, its gross margins and operating margins are higher. This reflects the capital-light nature of Netwealth’s business.
As a result, it has been able to produce as much free cash flow across a shorter period of time.
Netwealth has been able to deploy this free cash flow to improve its platform and continue to receive accolades from the industry.
Cash is king
In a market where revenue and earnings growth is all the rage, investors should also focus on a business’s ability to produce cash.
No matter how profitable the company is or how fast it’s growing, if it doesn’t generate cash, it will need to either raise capital or seek debt. This ultimately reduces optionality for the business.
There is a reason why a lot of people say, “Cash is king”.
