FCF metrics are very important to have in your checklist, so keep reading to learn which ones should be included in your arsenal↓
Peter Lynch, as well as several other very successful investors, made it a point to analyze cash flow and total cash. The reason being cash is much harder to manipulate than earnings making it a much better tool to evaluate companies with.
After all, any company, if they try hard enough, can hide debt and make earnings seem much better than they really are, but cash is much more transparent... it's either there or it isn't. Free cash flow is even harder to manipulate and is the core engine behind dividends, buybacks, and company reinvestment. FCF metrics are very important to have in your checklist, so keep reading to learn which ones should be included in your arsenal.
“Free cash flow is what’s left over after the normal capital spending is taken out.” — Peter Lynch
Cash in the bank is what every company, and investor, strives for. Companies with large amounts of cash have options to increase dividends, perform buybacks, or reinvest the capital back into their business. Cash flow is the amount of cash coming in minus the amount of cash going out of the company's bank.
Free cash flow (FCF) is a subset of cash flow and is the amount remaining after business expenses and capital expenditures have been paid, hence the term "free." In other words, this is the cash management can use to really create value for the company as well as shareholders. For simplicity sake let's use Apple as an example. We'll want to use at least a 5yr history for all out calculations to account for business cycles and to smooth out data.
Now that you understand what FCF is and why it's useful, let's look at some ways to integrate this figure by using it in 3 different valuation metrics:
(FCF / Revenues) * 100
Typically any number above 10-15% means the company is a cash-cow that has a significant competitive advantage.