Hi Mindmeld:
You calculate free cash flow (FCF) similar to the way I do---excluding changes in working capital from the definition and starting with net income, although I seem to recall that you used to start your calculation with "net cash provided by operations" rather than with net income. Many folks (possibly most) start their FCF calculation with "net cash provided by operations" from the cash flow statement; hence stock option expense is added back into their final figure (as is the case with Boeing) when stock options are expensed.
Some of these folks that start their calculation with "net cash provided by operations", are using the fact that FCF does not change when options are expensed, as an argument to minimize the importance of expensing stock options, characterizing expensing stock options as largely irrelevant with a refrain along these lines: "Free cash flow does not change, so I don't care what you do with earnings; my company is still growing free cash flow and doing well regardless of whether you expense stock options on the income statement or not".
In my opinion, however, there is a smoking gun that belies these stock options apologists' logic: That is the fact that that a portion of these "overstated" free cash flows often disappears in to share buybacks to counteract share dilution, which in turn reduces retained earnings on the balance sheet. This in turn begs the question: What relevance do these wonderful reported free cash flows have to shareholder wealth building capability when a portion of this reported free cash flow subsequently disappears from retained earnings in an effort to counteract dilution from exercise of stock options?
Mindmeld, while I have some education in finance, I am not an accountant. Feel free to point out any perceived inaccuracies in my thinking and accounting assumptions. However, I am reasonably certain that free cash flow as currently defined, for companies that heavily employ stock options, has very limited applicability as an investment evaluator.
Regards, Huey
P.S. I may have some issues with deducting business acquisitions from free cash flow depending on the situation and the purpose of my calculation. |
