Silicon Investor - Free Cash Flow as Value Criterion

[Harshu Vyas] Ok, I'm defining free cash flow a new way now: FCF = Adjusted net income (adjus...

Harshu Vyas — 9/16/2024 5:42:51 AM

Ok, I'm defining free cash flow a new way now:

FCF = Adjusted net income (adjusted for a normalised, true D&A expense*) after changes in working capital** (this can be adjusted, too, in industries where working capital cycles are more easy to map out) less total capital expenditures (not just maintenance capex).

Only then, can the cash be said to be "free."

What I suspect is that not many companies can continually yield high levels of "free cash" - any company that does have that earning power interests me deeply.

It's possible in a few months I come back to redefine it again. Appreciate any thoughts if anyone is on this thread.

*What I mean here is if amortisation isn't a real expense, it should be added back like it is on the cash flow statement. However, if the cost is real and not an accounting fiction, it cannot be added back. Also, if depreciation accounting is too conservative, you adjust it to make it more real.

** It's possible that this won't help analysts in certain industries in which case you skip it. But, for most companies, I think it's an important step.

[Harshu Vyas] I've been thinking about free cash flow for a while now. My thoughts are that th...

Harshu Vyas — 3/6/2024 11:12:38 AM

I've been thinking about free cash flow for a while now. My thoughts are that the definition needs changing.

When I work out free cash flow I subtract amortisation charges from cash flow from operations. They're just a non-cash expense and unlike depreciation, it doesn't matter if the company doesn't "acquire" (for lack of a better word) new intangible assets. Of course, this isn't the same in every industry and each situation is different.

I like the idea of "EBDIaT less capex" as a measure but I don't know what it'd be called.
EBDIaT would be earnings before depreciation (and) interest after taxes. Similar to NOPAT but a subtle difference.

What about changes in working capital? Well, some analysts don't bother with it. I do. I look at the long-term history and work out where the business is in the business cycle. Growing businesses will have growing receivables and inventory etc. meaning that their cash flows will be weaker than a declining business.

That's another problem. Free cash flow doesn't factor in whether a company's growing/slowing. Slowing companies actually look better to investors!

And then there's the idea of subtracting only maintenance capex. That's also foolish. The cash has been invested. You must subtract full capex. If the business is investing for growth (and in most cases, the growth is necessary for business survival), you have to subtract full capex. Yes, it makes the free cash flow numbers look "worse" but that's the true figure.

This is just a rant about what I'm seeing from analysts. Hopefully, we can have more of a debate about free cash flow.

[robert b furman] Just wanted to say Thank You for being well ahead of me in my thinking proces! ...

robert b furman — 1/31/2012 9:16:46 PM

Just wanted to say Thank You for being well ahead of me in my thinking proces!

Bob