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Technology Stocks : Cisco Systems, Inc. (CSCO) -- Ignore unavailable to you. Want to Upgrade?

To: RetiredNow who wrote (58473)	3/13/2002 11:21:21 AM
From: hueyone	Read Replies (1) \| Respond to of 77400

Brealy & Myers directly contradict your assertion that net working capital should not be included in free cash flow I could well be wrong on this, but I simply don't see the logic in calculating free cash flow your way. I think it is likely the definition you site is referring to "cash flow" rather than "free" cash flow. Your recital of Brealy and Meyer's definition did not state "free" cash flow. What we are trying to measure here is the earnings generated for owners from operations after investment in plant and equipment. If accounts receivable have already been booked in to net income, as they would be with accrual accounting, then how does converting accounts receivable to cash at a later date increase owner earnings? I agree with John Shannon here. I haven't looked at the Sredgar site yet, but generally I find sites like Quicken that automatically calculate ratios to be fraught with errors. There is no substitute for doing it yourself---(that is unless you are lazy like I am sometimes and just want to take Buffet at his word for items like real growth in GDP )<ggg> I really appreciate you and JS publicly sharing your hard work and plan to look over your entire calculations as soon as I get some time away from my regular job. Best, Huey

To: RetiredNow who wrote (58473)	3/13/2002 11:52:31 AM
From: hueyone	Read Replies (1) \| Respond to of 77400

I think you could calculate free cash flow your way to include changes in working capital quarter after quarter (and the changes in working capital would average out over time) but then your free cash flow could be subject to wild swings every quarter that simply depend on changes in the working capital account rather than fundamental changes in the business. I don't see how this will help you get a better grasp of how the underlying business is doing. Best, Huey

To: RetiredNow who wrote (58473)	3/13/2002 2:27:40 PM
From: Stock Farmer	Read Replies (1) \| Respond to of 77400

You, me, Brealy and Myers are agreed that to value a company that doesn't produce dividends one can use Discounted Free Cash Flow. Amongst other methods. And here: So from that, I think you and I can get a good proxy for free cash flows by taking net income and adding back depreciation, amortization, and investments in PP&E. Which, in the case of Cisco's most recent quarter was, as posted, 946 M$ or 20% of revenues. You wrote: further into the book, Brealy & Myers say, "[when estimating cash flows] Do Not Forget Working Capital Requirements. Net working capital is the difference between a company's short term assets and liabilities...Most project entail an additional investment in working capital. This investment should, therefore, be recognized in your cash-flow forecasts. By the same token, when the project comes to an end, you can usually recover some of the investment. This is treated as a cash inflow." I agree with Brealy & Myers here too! And hasten to point out that they weren't talking about "free" cash flow. Just "cash flow", in which case changes to working capital play a part. Look at their definition of working capital. I am pretty sure you'll agree that cash is classified as a short term asset. So when you reduce non-cash items in working capital and increase cash items in working capital the total working capital (liquid shareholder value) goes up by.... ... THE DIFFERENCE!!! Not just by the amount that cash goes up. We're trying to compute total SHAREHOLDER VALUE, so we also include changes to cash as a consequence of illiquid assets (again, net of any decreases). With the exception of the purchase of PP&E (offset by backing out depreciation) we don't include cash flow from investing activities for the same reason. And we don't include cash flow from financing activities 'cause equity financing comes from shareholders pockets in the first place. Absolutely there is a difference between 946 M$ of "Free Cash Flow" and the 2,007 M$ of "Cash Flow from Operations". Basicly, one is the cash flow contributed from outside the business by its operations, and the other is the cash flow from all sources. The difference has to do with the conversion of various non-cash assets into cash assets, plus contribution of cash from shareholders laundered through the IRS, plus actual cash cost of PP&E minus attributed prior costs of PP&E. I think you will have a hard time proving that one should value a company based on the toing and froing of money between various internal accounts. Why? We're trying to put some sort of $ per share value on the company. Let's forget for the moment that for the past few years, the market has decided that this is an irrelevant exercise. And let's forget that regardless of what the company is worth that there's a whole host of folks who will never part with their shares for a "fair" price. Let's pretend that we (you and me) plan to buy Cisco so that many years from now we can drain it of cash and make ourselves (just you and me) wealthy. We might have to let a few other folks in on the deal, but we'd only do that if they pay their fair share. Not a penny more, nor less. Now, how much would we pay? What would a "fair share" be worth? Well, in theory we wouldn't pay a dime more than we expect to get back. Anything less, we expect to make a dime. And a dime's a dime. Nothing entitles us to be error-free in our expectations, and so to reduce risk we try to use a standard quantitative measure to calculate our expectation and see if we feel comfortable using it. Not that it's any more or less right than using tea-leaves or goat entrails or Madamme Mimi. Just that it's what we've decided to use. So we plug in the heads that God gave us, and use them to come up with an explanation for what we expect. What do we expect to get back? Every asset that the business has, plus every dime of profit that we expect the business generates. We know what it's got. We can add that up. It's called "Shareholder equity". But we're going to pay more than book value for the company. In Cisco's case that's about $3 per share. How much more? Well, the discounted future sum of every dime that we expect flows into the coffers, that's how much. Pay more than that and we're signing up to expect to lose money. Dimes that flow. But not "cash flows" exactly. 'Cause some of this cash flow comes from our pockets through equity financing. We (shareholders) had this to begin with, so it's not like when we give more cash to the company it's something the company is giving us. We're just getting what we gave. So we'll forget about the cost, but we also have to forget about the value too. Net: $0.00 Also, some of this cash flow comes as a result of the business turning parts of itself into cash net of turning its cash into parts of itself. Hey, whether they are cash or IOUs or YouOMes or reserves or inventories or whatevers, we already own those things 'cause they show up in the book value of the enterprise!!! We're not so easily fooled as to count something we already own as part of the something extra we're going to get later. Well, at least we shouldn't be. So we don't count any of this toin' and froin' of cash. So that leaves us to add up the cash that's coming in from outside the business, minus what we have to shell out to keep the place generating cash. Hmmm... let's see. What comes in is called "earnings", 'cept it's polluted by this phantom thing called "Depreciation" which is where accountants keep track of the spending that went on in the past to keep the place generating cash. So we'll add that back in (we already paid for these assets, remember?), and instead we'll peek over on the cash flow statement and subtract off the actual expenses that were expended. Hmmm... that makes "Earnings Minus Depreciation (a negative number) Minus Expenditures on Property Plant and Equipment. Which is back to where we started. So to summarize. You and me and our buddies Brealy and Myers and many others all agree that having cash is very very important. But when we stop and take a snapshot of how much cash has "flowed" into the cash account it's important to remember the three sources. Stuff we contributed to the company Stuff the company had that they turned into cash (or vice versa) Stuff the company took in from companies owned by other shareholders. It's only the cash in the third source that will make us wealthier. So for the purpose of estimating a future value for the enterprise it's the only thing we can count as being additive to current assets. For the purposes of adding up how much cash the company can sling around? Well, by all means, doesn't matter where it came from. So I agree with you that cash flows inclusive of changes to working capital are important. Just not in the case of a valuation exercise. John

To: RetiredNow who wrote (58473)	3/13/2002 4:31:03 PM
From: Stock Farmer	Read Replies (1) \| Respond to of 77400

I think the problem with your logic is that you are allowing yourself to get too convoluted in your thinking. For instance, you keep talking about misplaced money from equity financing. I don't see any misplaced money. It's all there in cash and investments and retained earnings. Many businesses consistently manage to show accumulated net income, which is less than cash inflows. They do this by maximizing tax benefits. The whole goal of a business is to show as little taxable net income as possible to minimize the tax obligation. Stock options have been a great vehicle for this. As a result, what many tech companies have in their financials is a reduced retained earnings number and a lot of cash sitting on the books. You can't fault tech companies for using the tax laws to their advantage and that is just what Cisco, Microsoft and a host of other did. LOL... you have me wrong. I'm not faulting the tech companies. All power to them. I'm faulting investors. [EDIT: More to the point I'm faulting the logic that investors such as yourself are using] My "what's missing" analysis goes like this. Start with 20.5 Billion dollars of shareholder money. Add 15 Billion dollars of supposed profits. End up with 28 Billion dollars worth of assets, net of liabilities. A great number of which are not necessarily worth $1.00 on the dollar. You want to know what's wrong? Tell you what, you send me a check for $35 in US funds. You'll find the answer on the $28 money order in Canadian funds that I mail in return. I'm such a nice guy I'll even spring for the postage. John.