GeaSphere Retirement Income Investing

Free Cash Flow

There is quite of bit of noise for investors when trying to value companies. Most investors look at measures like PE or they skip to the cash flow statements of a company’s 10K report because of the unreliable nature of earnings. Not all earnings are created equal, ask yourself the question: “Are the earnings pure or are they elevated because of accounting tricks or other gimmicks that are not sustainable for the long run?” It is critical to evaluate the company’s free cash flow at least quarterly if not more often. Not all earnings are the same, and understanding the important ones and discounting the less important ones will have a direct impact on your investing success. An example of less reliable earnings would be when a company does not pay all vendors in a particular quarter and as a result the cash flow looks better or if they put off paying taxes for a period of time to improve cash flow in the most recent earnings reports. Most investors are not savvy enough to know the differences in earnings but they invest anyway usually at their peril. The most important lessons to learn is understanding that stock prices will follow growth in quality earnings and expanding margins often rewarding the stock with increased multiples for every dollar of free cash flow. Utilizing a strict definition of free cash flow and using it as religious doctrine will keep you out of trouble in the long run. Think of it in these terms, no company wants to pay more taxes than needed so they will take all measures to reduce their taxable income. Free cash flow is the final amount of money left after everything has been paid. If this is a small or a negative number then the value of the company at least in the short term is overvalued and the market will punish its stock holders with plunging stock prices. On the other hand if the free cash flow is a growing number relative to the price of the stock then the market will reward investors with rising stock prices. *Information provided in our posts is for sophisticated investors only. All others should contact GeaSphere Advisors for a free portfolio review and risk assessment to determine the proper investments and asset allocation models for their circumstances. GeaSphere Advisors will often hold positions in stocks or sectors we write about. Call 401-351-4900