Free cash flow (FCF) is the cash a company generates after capital expenses. Analysts use FCF to assess a company’s ability to generate profits, repay debts, and fund growth without relying on external capital. High FCF often indicates a strong business model and financial health.
What is Free Cash Flow (FCF)?
Free cash flow is the money left over after a company has paid for its operating expenses and capital expenditures. It represents the cash available to shareholders, creditors, or reinvestment back into the business.
It’s calculated as:
FCF = Operating Cash Flow – Capital Expenditures
A high FCF shows that the company can generate more cash than it needs to maintain and grow its operations.
Why is FCF Important in Stock Evaluation?
Free cash flow is critical because it reflects the real money a business earns. While accounting profits can be manipulated, cash flow is harder to fake. Analysts trust FCF to understand how much money a business truly generates.
High FCF can indicate:
- Ability to pay dividends or buy back shares
- Strong internal funding for expansion
- Flexibility in economic downturns
How Analysts Use FCF in Valuation
Analysts use free cash flow in valuation models like the Discounted Cash Flow (DCF) method. The idea is simple: if you know how much cash a company will generate in the future, you can estimate its current value.
Steps include:
1. Forecasting future FCFs
2. Discounting them to present value
3. Comparing with the stock’s market price
If the intrinsic value is higher than the current price, the stock may be undervalued.
What Does Negative FCF Mean?
Negative free cash flow isn’t always bad. For young companies investing heavily in growth, negative FCF could be strategic. However, consistently negative FCF for mature companies may signal financial trouble or inefficient operations.
Analysts compare FCF trends over time to check if the company is improving or deteriorating.
Free cash flow is one of the most powerful tools analysts use to find fundamentally strong companies. It reveals whether a company can sustain operations, expand, reward shareholders, and survive downturns—making it a key metric for smart investing.
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