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Welcome to Long-Term Mindset, the Wednesday newsletter that helps you invest better.

Today's Issue Read Time: <3 minutes

• Lesson: A tale of Shopify's losses that weren't
• Timeless Content: Advice for young investors (or young at heart)
• Thread: Net income versus free cash flow
• Resource: Farnam Street blog
• And more!

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Friends,

Meet Ted - a budding entrepreneur with a passion for investing. Back in 2022, the profits from his business allowed him to start investing in stocks.

Ted used Shopify in his business. Given the platform's ease, he thought it would make a great addition to his portfolio.

After a few minutes of research, he saw this...

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...and immediately decided to pass on the stock.

Who can blame him? Shopify was losing $3 BILLION, and the losses looked like they were growing.

That's too bad because the stock proceeded to do this:

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Sadly, Ted didn't understand a subtle nuance in accounting that can make net income an extremely misleading metric:

• Net Income is governed by accrual accounting, which is more opinion than fact. It is affected by non-operating expenses that may have nothing to do with the business.
• Free Cash Flow Is governed by cash accounting, which only reflects the movement of cash into and out of the core operating business.

Why does this matter? Because in mid-2020, Shopify made a major investment in Affirm, a buy-now-pay-later company.

Because of an accounting change in 2007, Shopify had to mark its investment in Affirm to market. In other words, if Affirm's stock went down, Shopify had to count it as a loss on the income statement (and visa versa), even if it didn't sell shares.

Since Affirm's stock nose-dived throughout 2022, Shopify's net income was dragged down with it. At least, that's how it looked on paper.

In reality, Shopify's free cash flow was in MUCH better shape than net income, even if it was also temporarily trending in the wrong direction.

This is why understanding the nuance of accounting is so crucial. There are numerous reasons why net income can mislead investors, such as mark-to-market accounting, non-cash charges, goodwill writedowns, and more.

Reliance on net income alone to make investing decisions can often lead to poor decisions.

This is why becoming fluent in the language of business -- accounting -- is a requirement if you invest in individual stocks.

It won't make you rich overnight. But it will be a solid investment in building the type of wealth that's the most rewarding -- that builds over the long run.

Wishing you investing success,

- Brian Feroldi, Brian Stoffel, & Brian Withers

P.S. -- Registration just opened for our newest course: Advanced Financial Statement Analysis. Click here to register. Use the code BBFRIEND300 for the largest possible discount. But hurry: this discount offer expires this Friday at 11:59 PM EST.

One Simple Graphic:

One Piece of Timeless Content:

If you invest, you should get to know Vishal Khandelwal. He has written a trio of books that make it easy to understand the mental models of investing & life. This short article on the advice he'd give a young investor is well worth a few minutes of your time (no matter how old you are).

One Thread:

Brian Stoffel @Brian_Stoffel_ Revenue and income are NOT the same thing Costs and expenses are NOT the same thing Net income and free cash flow are NOT the same thing Confused? Here's a quick breakdown: 7:25 AM • Sep 3, 2022 3456 Retweets 12053 Likes Read 125 replies

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One Resource:

Life is an open-book test. That's why we love Farnam Street's blog. It's filled with useful information that improves learning, decision-making, and life in general. The goal is to help you master "the best of what other people have already figured out."

One Quote:

More From Us:

📗 If you've read Brian Feroldi's book, he'd love a review.

👨‍🎓 The next cohort of our Advanced Financial Statment Analysis course starts in March! Enrollment is open now! Click here for details.