Best of the Week
Most Popular
1. The Trump Stock Market Trap May Be Triggered - Barry_M_Ferguson
2.Why are Central Banks Buying Gold and Dumping Dollars? - Richard_Mills
3.US China War - Thucydides Trap and gold - Richard_Mills
4.Gold Price Trend Forcast to End September 2019 - Nadeem_Walayat
5.Money Saving Kids Gardening Growing Giant Sunflowers Summer Fun - Anika_Walayat
6.US Dollar Breakdown Begins, Gold Price to Bolt Higher - Jim_Willie_CB
7.INTEL (INTC) Stock Investing to Profit From AI Machine Learning Boom - Nadeem_Walayat
8.Will Google AI Kill Us? Man vs Machine Intelligence - N_Walayat
9.US Prepares for Currency War with China - Richard_Mills
10.Gold Price Epochal Breakout Will Not Be Negated by a Correction - Clive Maund
Last 7 days
Is This Time Different? Predictive Power of the Yield Curve and Gold - 19th Aug 19
New Dawn for the iGaming Industry in the United States - 19th Aug 19
Gold Set to Correct but Internals Remain Bullish - 19th Aug 19
Stock Market Correction Continues - 19th Aug 19
The Number One Gold Stock Of 2019 - 19th Aug 19
The State of the Financial Union - 18th Aug 19
The Nuts and Bolts: Yield Inversion Says Recession is Coming But it May take 24 months - 18th Aug 19
Markets August 19 Turn Date is Tomorrow – Are You Ready? - 18th Aug 19
JOHNSON AND JOHNSON - JNJ for Life Extension Pharma Stocks Investing - 17th Aug 19
Negative Bond Market Yields Tell A Story Of Shifting Economic Stock Market Leadership - 17th Aug 19
Is Stock Market About to Crash? Three Charts That Suggest It’s Possible - 17th Aug 19
It’s Time For Colombia To Dump The Peso - 17th Aug 19
Gold & Silver Stand Strong amid Stock Volatility & Falling Rates - 16th Aug 19
Gold Mining Stocks Q2’19 Fundamentals - 16th Aug 19
Silver, Transports, and Dow Jones Index At Targets – What Direct Next? - 16th Aug 19
When the US Bond Market Bubble Blows Up! - 16th Aug 19
Dark days are closing in on Apple - 16th Aug 19
Precious Metals Gone Wild! Reaching Initial Targets – Now What’s Next - 16th Aug 19
US Government Is Beholden To The Fed; And Vice-Versa - 15th Aug 19
GBP vs USD Forex Pair Swings Into Focus Amid Brexit Chaos - 15th Aug 19
US Negative Interest Rates Go Mainstream - With Some Glaring Omissions - 15th Aug 19
GOLD BULL RUN TREND ANALYSIS - 15th Aug 19
US Stock Market Could Fall 12% to 25% - 15th Aug 19
A Level Exam Results School Live Reaction Shock 2019! - 15th Aug 19
It's Time to Get Serious about Silver - 15th Aug 19
The EagleFX Beginners Guide – Financial Markets - 15th Aug 19
Central Banks Move To Keep The Global Markets Party Rolling – Part III - 14th Aug 19
You Have to Buy Bonds Even When Interest Rates Are Low - 14th Aug 19
Gold Near Term Risk is Increasing - 14th Aug 19
Installment Loans vs Personal Bank Loans - 14th Aug 19
ROCHE - RHHBY Life Extension Pharma Stocks Investing - 14th Aug 19
Gold Bulls Must Love the Hong Kong Protests - 14th Aug 19
Gold, Markets and Invasive Species - 14th Aug 19
Cannabis Stocks With Millennial Appeal - 14th Aug 19
August 19 (Crazy Ivan) Stock Market Event Only A Few Days Away - 13th Aug 19
This is the real move in gold and silver… it’s going to be multiyear - 13th Aug 19
Global Central Banks Kick Can Down The Road Again - 13th Aug 19
US Dollar Finally the Achillles Heel - 13th Aug 19
Financial Success Formula Failure - 13th Aug 19
How to Test Your Car Alternator with a Multimeter - 13th Aug 19
London Under Attack! Victoria Embankment Gardens Statues and Monuments - 13th Aug 19
More Stock Market Weakness Ahead - 12th Aug 19
Global Central Banks Move To Keep The Party Rolling Onward - 12th Aug 19
All Eyes On Copper - 12th Aug 19
History of Yield Curve Inversions and Gold - 12th Aug 19
Precious Metals Soar on Falling Yields, Currency Turmoil - 12th Aug 19
Why GraphQL? The Benefits Explained - 12th Aug 19
Is the Stock Market Making a V-shaped Recovery? - 11th Aug 19
Precious Metals and Stocks VIX Are About To Pull A “Crazy Ivan” - 11th Aug 19
Social Media Civil War - 11th Aug 19
Gold and the Bond Yield Continuum - 11th Aug 19
Traders: Which Markets Should You Trade? - 11th Aug 19

Market Oracle FREE Newsletter

The No 1 Gold Stock for 2019

Free Cash Flow - The Best Company Valuation Metric

InvestorEducation / Learning to Invest Oct 02, 2012 - 10:10 AM GMT

By: Ian_R_Campbell

InvestorEducation

Why Read and Watch: Because Free Cash Flow is indeed the best valuation metric for established companies that generate cash flow from operations.

Featured Article and Video: A recent short article with an accompanying video purports to explain what 'free cash flow' is, and why and how it is important as a business valuation metric. On balance, the video does quite a good job of this - and hence is worthwhile watching and listening to.


Commentary: This article and video provides a quick overview to a very important topic that all investors (less so short-term traders) ought to know about and understand. Certainly the discounted after-tax free cash flow valuation methodology is the principal one relied upon by sophisticated companies in their acquisition analysis.

That said, the video presentation suggests that 'free cash flow' is defined as the result obtained for any given fiscal period when all capital expenditures incurred during that period are deducted from recurring operating income generated in that period. That is:

Recurring Operating Income - Total Capital Expenditures

=

Free Cash Flow

That is overly simplistic, and as both a theoretical and practical matter incorrect. This is because:

  • first, the video does not discuss income taxes. It is 'after tax operating income that is important, since corporate income taxes are a cost of doing business and need to be taken into account;

  • second, capital expenditures in any given fiscal period need to be separated between those capital expenditures made to:

    • first, sustain the business at its current operating income level, being that portion of any capital expenditures that are not discretionary - they must be spent (over and above capital maintenance expense) to ensure to the extent possible that the business is able to maintain its existing operating income levels; and,

    • second, promote growth in future operating income. Capital expenditures that fall into this category are of a discretionary nature, much like dividend payouts for example. Growth capital expenditures are expected, when made, to result in increases to current operating income - otherwise such amounts will not be expended

Four final comments:

  • the segregation of both historic and forecasted capital expenditures between those that are of 'a sustaining nature' and those that are of 'a growth nature' typically is a very difficult and subjective task - and one that would be generally beyond the ability of any investor or external analyst who does not have:

    • detailed information developed from discussion with company management, and

    • assistance from experts in plant and equipment technological change and 'wear and tear' (i.e. condition 'as is, where is';

  • in both theory and practice where full and detailed data is available, it is "discretionary free cash flow after tax", being properly determined 'free cash flow' after sustaining capital reinvestment and income tax. That is not the same thing as what is referred to in the referenced video as "free cash flow";

  • assuming a portion of annual capital expenditures is made to enhance corporate growth of operations and operating cash flow, to deduct total period capital expenditures from recurring period after-tax operating income is more likely to result in an understatement, not overstatement of business value; and,

  • the video is well worth watching, as subject to the foregoing, it is definitely 'on the right track'.

Video: Everything You Wanted To Know About Free Cash Flow

Source: Investing Answers, Even Perra and Luke Stenis, June 14, 2012. Reading and viewing time: 3 minutes.

Ian R. Campbell, FCA, FCBV, is a recognized Canadian business valuation authority who shares his perspective about the economy, mining and the oil & gas industry on each trading day. Ian is also the founder of Stock Research Portal, which provides stock market data, analysis and research on over 1,600 Mining and Oil & Gas Companies listed on the Toronto and Venture Exchanges. Ian can be contacted at icampbell@srddi.com

© 2012 Copyright Ian R. Campbell - All Rights Reserved

Disclaimer: The above is a matter of opinion provided for general information purposes only and is not intended as investment advice. Information and analysis above are derived from sources and utilising methods believed to be reliable, but we cannot accept responsibility for any losses you may incur as a result of this analysis. Individuals should consult with their personal financial advisors.


© 2005-2019 http://www.MarketOracle.co.uk - The Market Oracle is a FREE Daily Financial Markets Analysis & Forecasting online publication.


Post Comment

Only logged in users are allowed to post comments. Register/ Log in

6 Critical Money Making Rules