jbe, you gave me another big laugh - at myself! It's surprising the assumptions one can make on such a subliminal level that you don't even realize you're doing it. I have trouble coming up with a good reason for assuming "jbe" indicates a male. I guess the easiest explanation is that by far most of the people I meet here are male. I much prefer that to a darker theory involving prejudice. Anyways, sorry about that. Perhaps you could give me your name - "jbe" feels rather impersonal!
I'm going to tackle this one first:
"In this connection, I notice that some of the stocks you own or are thinking of owning have negative free cashflow in the present; obviously you expect that to change -- but how? and by how much? They do have good operating cashflow, which makes me suspect you might really paying more attention to that than to free cashflow. The only really stellar free cash flow performers on your list are American Express and Intel (rah, rah!). "
Ok, I'll admit to being very confused here. All of the companies that I listed (excluding MCD and obviously ANCR) were there because of my belief that they have a consistent history of POSITIVE free cash flows. So I wonder if we calculate the FCF differently? Here's a hunch - I disregard occasional charges to earnings related to aquistions, on the assumption that they cloud the company's true operating performance. And I don't throw them in with capital expenditures, because I tend to view them as "dividend" reinvestments rather than necessary maintenance for the growth of the company's existing core business. Same with "restructuring charges" - one time distortions of the "real" income statement. I'd certainly like to hear your opinon on this...
So when I calculate FCF, I take net earnings from the income statement (adding back any one-time charges) then go to the cash flow statement. There I add depreciation and amortization, and subtract "additions to plant and equipment" (or however that company describes it's capital expenditures). I've thought about adding back "deferred taxes" as well, because I heard that it's just unrealized capital gains, but I'm no accountant so I decided it would be more conservative to leave them out until I understand them better. And that's it. Like you said, it's best to only consider "necessary" capital spending...but I don't really know how to do that. Again, I figure that in absence of understanding, it's more conservative to subtract all of the cap. exp. for now.
So here I'll tabulate my calculations for the companies that I listed, and you can point out where we disagree if you want (numbers are in $millions):
Company ( Net Earnings) (D&A) (Cap. Exp.) (FCF)
COMS(97)*-- (640.3) (190) ( -380) (450.3)
AXP(96)-- (1739) (266) ( -438) (1567)
CSCO(97)-- (1557.1) (212.2) (-330.3) (1439)
NN(97)** -- (253.9) (83) (-131.6) (205.2)
NT(96)-- (623) (525) (-601) (547)
COHR(96)-- (30.3) (12.4) (-24.9) (17.8)
MCD(96)-- (1572.6) (776) (-2375.3) (-26.7)
INTC(96)-- (5157) (1888) (-3024) (4021)
EK(96)-- (1519) (903) (-1341) (1081)
UTR(96)-- (20.7) (11.7) (-18.7) (13.7)
*COMS - with the merger this year, earnings are based on company's estimation of what 97 would have looked like if COMS and USRX were already combined. D&A and Cap. Exp. are my estimations. Both companies seperately had positive FCF in the past.
**NN - numbers are in $CDN
So those are the numbers I used to get present positive FCF for all except MCD. What do you mean when you say "stellar FCF performers"? Do you mean some sort of FCF margin? I like the idea of that - it would kind of show how "solidly" they are in the black. I think I'll add that to my spreadsheet...
As for your question, I outlined on the MCD thread why I think their FCF will turn positive in the future. Like you said, the difficult part is deciding HOW positive!
I normally don't even try to do a valuation on companies with negative FCF. Unless you have a compelling argument for an improvement, I don't see how such a company could have ANY value as a going concern! (to an investor anyway)
" You are clear enough about how to estimate the discount & growth rates, but I do not understand how you estimate the key parameter -- future free cash flow. "
This is what I was talking about when I suggested using a conservative growth rate. By growth rate, I mean average growth in (positive) FCF over a period of many years. I don't think it's worthwhile to try to map out each year's specific number. I mean, can you imagine going "well let's say 120 in 98, 140 in 99, then maybe there'll be a recession in 2000, so only 130 that year, but then a rebound to 150 in 2001..."? I think that the extra trouble in doing that won't pay off, because you're assuming too much precision. So I try to smooth it all out over a period of say 10 years by making a GUESS at what a reasonable cumulative annual average might be. Take the networking industry for example. People tend to agree (rightfully I think) that this industry has a bright future of growth ahead of it. So for a company like CSCO, the consensus is that they are going to grow somewhere between 25% to 35% a year for the next several years. Not wanting to bet my nest egg on their optimistic projections being right, I say "well at today's prices, does a purchase make sense even if their FCF grows at only say 10% or 12%?" So there's no magic, just conservative optimism. But you want to understand what this company's doing, and be confident that you really are being conservatism. I know it's impossible to guarantee anything, but if you're buying stocks for the long term already, you're pretty much already going through this thought process ANYWAY. You probably are already conciously assuming "fast growth" or "slow growth" or something. So why not put something down on paper to see if the numbers make sense?
"I still feel more comfortable dealing with PRESENT free cash flow: I like to feel reasonably secure, and only companies with lots of cash in the bank and minimal debt make me feel that way. I suppose you might say I operate on the principle that a bird in the hand is worth two in the bush."
I agree with you totally. Before I do a valuation and after some qualitative analysis on the company's prospects, I check for the following:
1. ROE above 20% or so (assuming not a lot of debt or "leverage")
2. Net Margins above 10% or so.
3. "High" gross margins (it depends on the industry a lot)
4. Positive FCF (obviously!)
5. "Low" debt.
6. More cash than debt.
7. Demonstrated and prospective average growth at least 10% to 15%
"You might be interested to know what companies I have actually bought that meet my criteria (which also include good sales/eps/cashflow growth, "reasonable" p/e's, good ROA and ROE, etc.). For simplicity's sake, let's just look at the price/cashflow ratio (S&P average: 16.52) and the price/free cashflow ratio (S&P average: 37.86). "
I'm sure you'll do well by picking these kinds of companies. But when it comes down to valuation, what's a "reasonable" P/E or P/F? If there's a bear market and everybody's P/E goes down, how will you be able to comfort yourself that you paid a reasonable price, allowing you to be patient and wait for the market to prove you right? That's the problem I see with "relative" valuation by comparing say Intel's P/F with that of the S&P500. Maybe we're at insanely high valuations across the board, and it's just a matter of time before we all crash back down to sensible valuations. Comparing your ratio with the S&P doesn't help you there. With "absolute" valuation like I'm talking about, you know what you're paying for. When the market plummets for no apparent reason, or because some analyst got bored and downgraded the stock, you can sit tight, knowing that 10 years from now you'll be laughing about it.
"Of course, there are many ways to slice this salami, but note that Intel turns up on almost all of my screens. Looking at the above numbers, I have hopes you will decide that Intel is indeed "cheap enough" for you, for a purely selfish reason. If Intel gets any cheaper, I shall have to sell it, despite all its virtues, because it will have triggered my automatic sell signal, which is when any stock I own falls below 10% of the purchase price. "
Intel is a fantastic company. I don't think you should sell it if it drops 50%. Just buy more in that case. If you've done your homework on a company, and know that you got a good deal on it, just ignore the short term fluctuations. There's so much short term momentum trading going on that you could be constantly bailing out of great stocks. How will you know when to get back in? Once the relative strength goes back up, you've already missed out on the chance to get back what you lost by selling. There are statistics that show that the vast majority of the gains in stocks are made in quick, completely unpredictible spurts, presumably related to news and resulting buying panics. To catch these, you have to be on board. I'm an efficient market atheist. I beleive that short term market movements generally have nothing to say about a company's intrinsic value. If you own great companies, just ignore them and save yourself the commissions.
"One of the basic problems with using free cash flow as a value criterion is that not many people use it; hence, it is not recognized by the market as a whole, which does not pick up quickly on what you and I might see as bargains. "
I agree, but have patience. I believe that today's free cash flow per share is the fuel for tomorrow's higher free cash flow per share. With it, companies can invest for higher growth, or buy back shares, increasing the value of your shares by increasing the percentage of the company you own. I see the lack of interest in FCF to be totally to our advantage. It makes for some great bargains.
I'll have to take a look at some of those companies you mentioned.
Andrew ( alas, a he...) |
