In case you've been wondering, this workshop is going spill over into next week. This week I will finish describing the different items in the Ratio Analyzer. Then, I will take a couple of sessions to look at a couple of companies.
Today we look at the Cashflow Ratios:
- Cashflow (annualized change)
- Free Cash Flow Margin
- Return on Free Cash Flow
- Free Cash Flow per Share
- Net Income (annualized change)
- Net Cash (annualized change)
- Cash Position per Share
It is said that cash is king. And it is certainly true that, at least in the short term, that the availability of cash determines how a company operates on a day to day basis. Without cash, a company's may not be able to meet short term obligations. So, we look at how cash "flows" through a company. This is another way of looking at how the business operates, and it may give us the most transparent view at the company's inner workings.
When we look at cashflow, we are simply following the cash money in a company.
The first item is the Annualized Change in Cashflow. This compares the influx of cash this year, as compared to a year ago.
Cashflow (annualized change) = 100*( (( Cash from Operations this year)/(Cash from Operations prior year)) - 1 )
This calculation is always based on a year that ends with the currently selected quarter. We look for cash flow to increase, as the company grows. And, we would like to see cash flow increasing at least as fast as sales increase.
Free cashflow is that remaining after a company funds its capital spending projects and pays its dividends. The Free Cashflow Margin compares the Free Cashflow to the company's Revenues
Free Cash Flow Margin = ( Net Cash from Operations - PP&E - Dividends ) / ( Revenues )
This tells us the percentage of a company's revenues remain after major spending is completed. Our metric is that a margin that is 10% or more is good.
Free Cashflow Per Share puts a dollar value on the free cashflow. It is calculated by dividing the Free Cashflow by the number of shares outstanding.
This money is available for management to use as it sees fit: to buy back shares, to acquire other companies, or to invest in additional plants, property, and equipment. When you purchase a share of the company's stock, you are, in essence, also buying your share of the free cashflow. If the Free Cashflow Per Share is substantial, you can think of this as cash that you have purchased, and it reduces the "risk" in your purchase.
Looking at your purchase of cash, are you earning a good return? The Return of Free Cashflow tries to answer this question in two ways. First we look at your return, based on the current price of the stock.
Return on Free Cashflow = ( Free Cashflow Per Share ) / (Closing Price this quarter)
This gives the return. If you compare that return to what you could earn if you invested in a 10-year bond (a very safe investment), you'll see if your investment is making money, comparatively.
For the final numbers in the Cash Flow analysis, we switch from cash flow, to cash -- simply the amount of cash that exists in the company. Cashflow focuses on cash from operations this year. Net Cash includes all of the company's cash.
We also look at the annualized changes in Net Income and Net Cash. We want to see both of these growing, and we would also like to see Net Cash growing at the same rate as Net Income.
Our final ratio is the Net Cash Per Share. If this is substantial, compared to the price of a share, it also reduces your risk.
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Let us compare Microsoft and Airgas again.
Microsoft's Cashflow looks good, with the sole exception being the rather low rate of return on free cashflow. Microsoft's cash per share is also small, especially compared to the price. In total numbers (multiply the net cash per share by the number of shared), though, Microsoft has a substantial amount of cash in its coffers. You may recall that Microsoft made a one time dividend payment of $3/share several years ago to lower the cash per share. This was, at some level, an acknowledgement that they had more cash than they knew what to do with, and investors were demanding a payout!
Unlike Microsoft, Airgas seems to have some problems in the cashflow department. In particular, free cashflow and all of the items related to free cashflow are negative! Net Income, Net Cash, and Cashflow are growing, but it appears that the level of cash coming in is not sufficient. I would think that some further digging is needed to see how Airgas continues to operate.
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Tomorrow I will look at the Profitability Ratios and the Asset and Inventory Ratios. Then, starting Monday, I will take a detailed look at several different companies. If you have a company of interest, mention it here, and maybe that will be one of the companies that I examine in detail. |