To: porcupine --''''> who wrote (338 ) 5/19/1998 4:26:00 PM From: jbe Respond to
Porcupine -- I have visited your website (GADR), and find it very, very interesting and informative. I do have a few questions about your methodology, which I hope you can address.or discretionary) -- to compute what they call "free cash flow." (They do not figure in changes in working capital, in other words.) You prefer to use it to compute what you call "cash earnings."current cash earnings situation of a particular company to the Dow, or the S&P, or the whole universe of stocks out there. You simply calculate the current P/CE ratio for company A, and then compare that to the average price/free cash flow ratios for the S&P, or for the industry it's in, or whatever, supplied by the web reporting services. projections . I can see how you would work out a 12-month, or a 5-year, projection for Company A -- but for the whole S& P? For the whole industry? That would involve working out ratios for every individual company you wanted to compare Company A to, and then feeding all that data into a computer program. Do you have such a computer program? I ask because the P/CE of Company A would be meaningless, without some standard of comparison, which could tell you whether its ratio was "too high," "too low," or "just right." (Not that I want to invoke any bears here.)...Cyclicals....tend not to be great companies. They're capital-intensive, and they usually need tons of debt to leverage their operating returns on capital into competitive returns on equity. For example, GM's return on equity...was 35% in 1997, in the same ballpark as noncyclical Gillette's 29% ROE. But whereas Gillette's debt level was just a fraction of is equity, GM's debt was 11 times -- yes, 11 times -- its equity. GM needed all that debt to leverage up its lowly 2.7% operating profitability (i.e., ROA). Gillette, on the other hand, generated an above-average ROA of 13%, so it didn't need a lot of leverage to jack up its return on equity. ..On the plus side, GM generates a lot of free cash flow. This means that even after spending money to upgrade its plant and equipment-- and GM spends a lot, more than $10 billion in 1997 -- the company still has more than $6 billion left over. With this money, it can pay more dividends, buy back stock, pay down debt, build cash reserves, or make acquisitions. GM has such low operating returns that it doesn't make much sense for the company to hold on to its free cash flow.
