Hi Joan, I'm back..
First, re: Morningstar's method. I agree with them, and I very much enjoyed their reasoning. Calculating free cash flow should be done for the purpose of uncovering the true economic return from the business(I think that's a relatively uncontroversial statement - notice I didn't say value yet!) because we all seem to agree that earnings are misleading, low in information content, and easy to manipulate. Abrupt changes in working capital such as Compaq's sudden decrease in inventories are only going to obscure how much cash they get on an ongoing basis while participating in the PC industry. While it may certainly be noteworthy that that happened, it does not belong in your FCF analysis, because it will distort the operating results. Should one really expect that Compaq's future is likely to be a consistent plummeting of inventory expenses? I think that's obviously absurd. So the dollar benefit to this year's FCF is misleading and anomalous. However, the benefits of this just-in-time inventory may well be far more important than the one-time bonus anyway. It may help them to compete better with Dell, avoid large inventory write-offs and generally create more free cash flow in the future. So I think that little tidbit belongs more in your qualitative opinion of Compaq than your FCF calculation. Besides, by their very nature, CHANGES in working capital are important are likely to be small relative to other factors; large changes are more than likely abnormal.
Pirah:
"Apply consensus growth rates, since this is all fuzzy anyway, and we should
be as wrong as anybody else."
You should put this on a T-shirt...
Oh yeah, Joan, the person who was showing you how to get FCF margin from your data providers looked to be on the right track. The math looks Ok anyway! I think it certainly may be a meaningful "Qualitative" tool (as a opposed to a valuation tool).
Andrew |
