Analyzing Free Cash Flow for Stock Valuation

By Stock Research Pro • December 3rd, 2008

Free Cash Flow (FCF) represents the cash that a company has generated after paying out expenses (salaries, bills, interest on debt, taxes, etc.). As such, it is a measure of the profitability of a company’s operations. FCF is calculated by subtracting capital expenditures from cash flow from operations.

Free cash flow is important to the company as it allows for the pursuit of opportunities for expansion and other ways to increase shareholder value. Companies that are short on cash are often not able to pay dividends to shareholders. Furthermore, insufficient FCF for can force a company to increase its debt levels.

Efficient Use of Free Cash Flow

Many investors see FCF as an important standard by which to measure the financial health and operational efficiency of a company. Still, the company must be wise and efficient in its use of FCF to create real value to shareholders. Companies that simply hoard their cash or spend it in ill-advised ways will not deliver any real value from their efficient operations.

The Price to FCF Ratio

Price to free cash flow is a valuation metric that compares a company’s stock price to its annual free cash flow. This measure is similar to price to cash flow but more strict by removing capital expenditures from cash flow. Generally speaking, the higher the price to free cash flow measure, the more expensive the stock.

Growing free cash flows are often seen as a prelude to increased company earnings and appreciating stock price.


The above information is educational and should not be interpreted as financial advice. For advice that is specific to your circumstances, you should consult a financial or tax advisor.

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