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Strategies & Market Trends : Free Cash Flow as Value Criterion -- Ignore unavailable to you. Want to Upgrade?

To: jbe who wrote (29)	10/28/1997 1:46:00 PM
From: Pirah Naman	Read Replies (1) \| Respond to of 253

Hi jbe: > Alas, I have seen no response to the system I have been using to > zero in oncompanies with great free cash flow. (See post opening > this thread, plus messages #5, #7, #19.) I just went back and looked. It seems as good a method as any. Also the weekly VL lists greatest free cash flow generators. That is the VL 40 page thing that lists all VL stocks, not the weekly review of some of the stocks. > Who was it that said MLHR looked expensive, with regard to free cash > flow? Twas I. According to the most recent review of MLHR in VL, it is projected to have cash flow of 3.30 in 98, with capital expenses of 1.95 (FCF ~ 1.35); in 2001 it is projected ot have cash flow of 5.15 and cap exp of 2.20 (FCF ~ 2.95). BTW, these figures were higher than for 97. I admire the company, but with low profit margins and these FCF figures, I consider it a bit expensive. I agree with you 100% about the importqnce of current FCF. Pirah

To: jbe who wrote (29)	10/28/1997 9:47:00 PM
From: Andrew	Read Replies (2) \| Respond to of 253

jbe and Pirah, I'll toss in a few comments on the posts you guys put up today. First, jbe...I guess I didn't directly comment on your "screening" methods. Guilty as charged (the last couple of days have been kinda crazy). I think your approach looks very solid. I mean the qualities you look for: high and growing FCF, high ROE, low debt, etc will definately go a long way to only selecting very high quality companies. As for valuation, I indirectly commented when I asked you guys (who both use short term P/FCF ratios) how you can say that a company is truly cheap this way. I think the only thing it can tell you is whether or not a stock looks relatively cheap. I know you guys don't like the idea about discounting cash flows back from the distant, murky future, but as Bill pointed out, it's the cash the company will pull in that matters. I will however concede that past performance is a good way of telling how a company may tend to perform in the future (ie strong companies tend to get stronger). So you have great companies, likely to keep being great, that also look cheaper than the rest of the market based on the real economic indicator of "profit" (FCF). I think that this has got to be a great way to invest for the long term. But I ask again, what if we go into a prolonged bear market, and the growth companies with great FCF sell at an FCF multiple of 8 for years because everyone is so pessimistic (like they were in the 70's). Since you paid a 14x, you stock is way down. For potentially years. What will you have to calm your frustration? How will you be able to say "I paid a fair price for a great company, and when times get better, the market will recognize this"? What if 14x isn't a fair price? Maybe it is, but when the rules change for a while, how will you know? That's why I see value in MCD, and you guys don't. My method allows for changes. I think MCD's is very likely to go from low FCF to very high FCF over the next ten years. If I'm right, there's alot of value there. But you could never see that value by looking at present P/FCF. Ok, significance of net margin. Despite the fact that we all agree that FCF, not earnings, are the true economic benefit of owning a company, net earnings are a very big component of FCF! We're saying "Don't forget those Capital expenditures!". But let's not forget those mundane expenses either! Net Margin suggests how well a company's operations perform relative to the costs of actually performing them. FCF = Earnings + D&A - Cap. Exp. (simply put). So for big FCF, you need big earnings. And higher net margins give you higher earnings. An inefficent but non-capitally intensive company may earn $1 billion a year on 1% net margin. That gives lots of FCF. But if their expenses get out of line a teensy bit....voila! No FCF! A company with 10% net margins has much more "secure" FCF. Re: Comparing methods: we're all basically looking for companies having lots of FCF per share compared to their growth rate in some way. Realistically, given the same set of data to work with we should generally turn up a lot of the same companies. Probably though, when you compare qualitative differences, such as optimism about prospects, understanding of company types, we'll choose to emphasize different companies. If for example, I think that COHR has an incredible future ahead of it, a multiple that looks high to you guys may seem like a bargain to me. And vice versa. Re: Comparing math results: Pirah, the answer to your puzzlement may be that VL "fudges" numbers a little. I've found many instances where VL (rightfully I think) will ignore major one-time charges related to restructurings or aquistions in order to provide a better picture of how the business is doing on an operating basis. I think aquistition charges don't belong on the income statement (ie, shouldn't subtract from earnings). IMHO, they obscure rather than illuminate. So you might see higher FCF than jbe for companies making aquistions, or lower for companies recording one time gains on sales of divisions. Sometimes the differences between the actual financial statements and VL are more subtle though. I just chalk it up to the analyst trying to give a better picture of what's going on. As for those websites, it's tough to say how they make the calculations. I try to stick to 10K's whenever possible, so I know exactly what assumptions are being made. Andrew