Silicon Investor (SI) -- The First Internet Community

STOCKTALK

We've detected that you're using an ad content blocking browser plug-in or feature. Ads provide a critical source of revenue to the continued operation of Silicon Investor. We ask that you disable ad blocking while on Silicon Investor in the best interests of our community. If you are not using an ad blocker but are still receiving this message, make sure your browser's tracking protection is set to the 'standard' level.

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

To: RetiredNow who wrote (62732)	1/19/2003 12:40:23 PM
From: hueyone	Read Replies (1) \| Respond to of 77400

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.

To: RetiredNow who wrote (62732)	1/21/2003 2:14:22 PM
From: bofp	Read Replies (1) \| Respond to of 77400

The right way to do this is to model the sharecount increases along with the cash flows then add the additional paid-in capital and the tax shield value of the option strikes. Divide each years cash flows by that year's share count, then discount back each year's free cash flow per share to the present day. Summing the present value of a single share should give you DCF value. Of course this valuation method is very sensative to the assumption that only the diluted shares in a particular period have claim to the FCF generated in the same period. IF the company accumulates the cash instead of paying a dividend or buying back shares, then the options that vest in future years will also have claim on those assets. Essentially, this means that the appropriate diluted share count in any given period is actually the number of shares that are anticipated to participate in the distribution of excess cash once it occurs. Since Cisco chooses to hoard cash and only periodically buy back shares, this cost is heavy indeed.