This is absolutely the meatiest exchange I have had since I started prowling these boards! Even though there ain't nobody here but us chickens (proof of lack of interest in FCF, which, as you say, may be to our advantage).
How do I calculate free cash flow? Let me confess: I don't calculate it. Like yourself, I'm no accountant, and I'm no mathematician either (see section "free cash flow valuation model" in Chapter Six of Hacket/Livnet book if you're better at equations than I am).
So, I rely on others to do my calculating for me. There are three web sites I regularly check:
1) Wall Street City's (Telescan) site: Corporate Snapshot. I am a subscriber, but if you are not, you can access the Corporate Snapshot for free, by going to Wall Street Research Net: wsrn.com
When it opens up, hit "company research"; when the next page comes up, type in the name of the company you want to research, and when the next page comes up, hit "Telescan chart 2-year" (very misleading title), and then, presto digito,. you have the Corporate Snapshot. (There must be a simpler way to do this, but I don't know what it is.) Then hit the button "edit this page", and you will get a whole list of parameters concerning virtually everything except debt, ROA, and ROE.
In any event, there are two parameters here that I check: free cash flow per share (called, for some reason, "cash flow/share free"), and (operating) cash flow growth (5-year, 3-year, 1-year). They give the numbers, and the rankings (vis-a-vis the S&P). ( Unfortunately, Telescan often has bugs, and right now, alas, the "free cash flow per share" parameter has come down with a bad one. It is spewing out "n/a" for every company you ask it about.)
2) The second site is MarketGuide, where I check the ratio comparisons. (Costs $5 a month, but it's worth it.) Here, the company is compared not just to the S&P, but to its own sector, and its own industry.) I check the price/cash flow ratio and the price/free cash flow ratio.
3) But these numbers reflect only the present moment, of course. For a historical view of a company's free cash flow situation I turn to Morningstar (a GREAT site -- and FREE): morningstar.net
Morningstar has a feature called "Quicktake," which is a misleading term, because it is actually quite comprehensive, being essentially a summary of the 10-K going back six years -- except, alas, for the cash flow statements, which go back only three. But three is better than nothing. Like the 10-K, they take net income, add in depreciation/amortization and deferred taxes to get operating cashflow, then subtract capital spending to get free cash flow.
What I look for here is accelerating free cash flow growth. And this is why I call the performance of Intel and American Express (to a lesser degree) stellar: not only do they have a lot of free cash flow, but the rate of free cash flow growth is accelerating. Cf. MCD, where the free cash flow situation has been getting progressively worse (and the debt level has been slowly creeping up).
By the way, unlike yourself, Hackel & Livnet pay a lot of attention to the price/free cashflow multiple. In fact, they build a portfolio around it. Their free cash flow-based valuation model assumes that free cash flows will remain constant at their most recent four-year average level (I can only go back three years, alas), and that the firm has low debt levels, and is unlikely to need additional future borrowing.
For their model portfolio (they are both connected to a securities firm), they select firms with 1) low free cash flow multiples (four-year average) -- more specifically, in the bottom 20% of all companies over $100 million in capitalization (multiples no higher than 15); 2) Total debt no more than 40% of net worth and a low debt multiple (i.e., total debt divided by the average free cash flows is less than 5); 3) The firm exhibits strong growth rates in operating and free cash flows over the most recent four years and eight years and shows consistent free cash flows over a long horizon that will include at least one business cycle. (Point three is, I think, hopeless for the amateur investor: where would one get the data for it?)
In any event, they claim their portfolio has outperformed the market by a significant degree.
I am not quite as fanatic about free cash flow as Hackel & Livnet, because I really don't want to bet the farm on one single parameter. There are so many different stock-picking systems out there, and who am I to say that none of the others have anything to be said for them? But my instincts all tell me that free cash flow is important, and it is the first thing I look at.
There are some other points you raise in your last message that I would like to respond to, but duty calls, and I'll have to address them in my next post.
Regards,
Joan |
