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Strategies & Market Trends : Gorilla and King Portfolio Candidates -- Ignore unavailable to you. Want to Upgrade?

To: hueyone who wrote (53969)	5/4/2003 8:56:21 AM
From: Stock Farmer	Read Replies (1) \| Respond to of 54805

Yes, depending on one's definition, we can calculate anything we want. The suggestion I am making is that rather than embrace a definition and use it willy-nilly, we should determine whether or not the definition makes any sense. So if we are trying to use something from which we will measure some equivalent "yield", as Mike was doing, then at least we should have the sense to test our definition to see whether it delivers sensible results. In this case, the measurement we are trying to make is "rate at which company is GENERATING spendable wealth". Not "rate at which company is recycling wealth". And by several tests of reasonableness, whatever basis Mike is using to calculate Free Cash Flow is undoubtedly inflated to include the latter element. I tend to use classical definitions. The whole "new economy" paradigm of metrics by which we should "value" tech stocks was the kind of stuff in vogue during the bubble. Which failed to detect over-valuation then. Now, some folks think this is somehow old fashioned. But if I look down at the gas tank indicator thingy and it says full and then the car runs out of gas, I'm really not likely to be driving around using that same gas tank indicator thingie next time as the reason that I've got lots of gas in the car. Some folks seem to behave much differently. Cash flow is like gas, and the metric free cash flow is kinda like that gas tank indicator thingy. And I still see a lot of people running around tryin' to tell folks the needle's up there on full! Seems to me we should be asking ourselves "what's wrong?" The "new era" free cash flow would have us take cash flow from operations and subtract cash capex and be done with it. But Financial Engineers have discovered that if one can take operating assets and liquidate them in the course of operations that this adds to "cash flow from operations", and that enough people are clinging to a dogmatic shortcut it makes this behavior worth while. If there is a way to purchase suitable assets, e.g. through financing activities, then we can take the cash that's generated by the business, and use it to generate itself again in a future quarter. A kind of cash-go-round. So when I see a company generating 0.3 B$ in revenues-minus-cost before taxes and more than 0.5 B$ in "operating cash flow" ... well, I suspect people should think twice about using "Operating Cash Flows" as the basis from which to value a company. Like they would think twice about trusting a gas tank indicator thingy that always shows "nearly full". Such a company is just not making its owners as wealthy as a company that's generating 0.6 B$ in revenues-minus-cost before taxes and injecting 0.1 B$ into working capital. No sir, it's not. But Mike's definition would have us think otherwise. So either Mike's definition is baked, or we've got a screwy way of looking at what makes us wealthier. Financial engineering is an art. And it relies on a naive and dogmatic use of shortcuts. We can fix naivete. We all start out naive until we learn otherwise. So here's a few facts we can chew on. The classical definitions. (1) Free Cash Flow = Earnings + D&A - Capex ONLY when operating cash flow = Earnings + D&A then (2) Free Cash Flow = Operating Cash Flow - Capex. But when Operating Cash Flow is not equal to (Earnings + D&A) ... then we are in trouble using Operating Cash Flow as the basis of a free cash flow equation. Which is where Mike is going off the rails. The "adjustments" he is making to Operating Cash Flow (e.g. to remove the tax effect of stock options) aren't sufficient. He's neglected to adjust for other very real cash flow sources that are non-income generating. John