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Free cash flow, it's applications and how they are calculated

simoan
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Re: Free cash flow, it's applications and how they are calculated

#142364

Postby simoan » May 30th, 2018, 4:32 pm

Gengulphus wrote:Well, if you don't want to get involved in a discussion about something, I'd seriously recommend not taking potshots at it!
Gengulphus


For the last time, I was not taking a potshot at anything. Do I regret mentioning "HYP" to Matt though, yes, too bloody right!! The trouble is once you let the HYP genie out the bottle on Lemonfool it never goes back in. No further comment from me but I await the hordes of HYP follow ups to ruin an interesting thread about free cashflow any minute now... A real shame.

All the best, Si

Melanie
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Re: Free cash flow, it's applications and how they are calculated

#142372

Postby Melanie » May 30th, 2018, 5:06 pm

:lol:

Very good. But I'm still none the wiser as to whether my conjecture HYP fraternity == investors fixated on prior high dividend yield history was correct.

?

Itsallaguess
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Re: Free cash flow, it's applications and how they are calculated

#142375

Postby Itsallaguess » May 30th, 2018, 5:17 pm

Melanie wrote:
Very good. But I'm still none the wiser as to whether my conjecture HYP fraternity == investors fixated on prior high dividend yield history was correct?


'Fixated' might be the wrong word....perhaps better to say that they put a 'high initial priority' to a high-yield...

But if someone then tried to convince you that the HYP Strategy singularly pursued a high-yield at the expense of any other financial metric (as they were always 'ignored'....), then that simply wouldn't be correct....

Cheers,

Itsallaguess

Melanie
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Re: Free cash flow, it's applications and how they are calculated

#142379

Postby Melanie » May 30th, 2018, 5:30 pm

Sorry I see I was kind of answered by in this post.

viewtopic.php?p=142319#p142319

Anyway I get the gist. I have briefly read up on differing styles of share acquistion e.g. "income", "growth" and "value" stocks, so we are not completely green in the gills.

To be honest, we are interested in all these strategies, just trying to learn, and hopefully make more money than we lose!

FWIW, my Dad has owned shares since the early 90s, and he just look at the FT a bit (he mainly just knows about p/e and eps), and buys. Usually in pretty dull, but oldish firms that he reckons will go on forever. I think he has:

NG
L&G
Standard Chartered
Balfour Beatty
BP
...

he always has BP, because he worked for them all his life ;)

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Re: Free cash flow, it's applications and how they are calculated

#142392

Postby Gengulphus » May 30th, 2018, 6:13 pm

Melanie wrote:Very good. But I'm still none the wiser as to whether my conjecture HYP fraternity == investors fixated on prior high dividend yield history was correct.

?

That's not about free cash flow, and is probably a subject for the High Yield Shares & Strategies board rather than Share Ideas.

If it's a subject for any board at all, that is - describing someone as "fixated" about anything is at least a borderline personal attack, implying that they're less than rational on the subject. And describing a group of people in that way just means that the attack is aimed at lots of people rather than just one, which doesn't make it any better!

So if you do want to raise the subject, I'd recommend removing any reference to people from it - something like HYP strategies pay too much attention to prior high dividend yield history would seem to me to be an alternative form of your conjecture that is definitely not a personal attack. That's only a suggestion and you may have an alternative wording that better reflects your intended conjecture - but if you can't reword it to be about the HYP ideas rather than about the people who use HYP, it probably isn't suitable to be on TLF at all.

Gengulphus

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Re: Free cash flow, it's applications and how they are calculated

#142396

Postby Melanie » May 30th, 2018, 6:40 pm

Itsallaguess wrote:Interesting thread Matt, so thanks for sticking with it and teasing out some of these issues.

So presumably

Dividend cover ratio =  FCFps / total value of planned dividends for the year


?

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Re: Free cash flow, it's applications and how they are calculated

#142421

Postby Itsallaguess » May 30th, 2018, 9:08 pm

Melanie wrote:
Itsallaguess wrote:
Interesting thread Matt, so thanks for sticking with it and teasing out some of these issues.


So presumably

Dividend cover ratio =  FCFps / total value of planned dividends for the year
?


Not normally -

Dividend cover would be describing the ratio of net profit compared to the dividend payout. Wikipedia describes it as -

If a company has net profit after tax of 2400 divided by total ordinary dividend of 1000, then dividend cover is 2.4.

https://en.wikipedia.org/wiki/Dividend_cover

The problem for income investors is that the net profit after tax might still be required to feed many more business-related mouths before it would ever get near being able to pay out into a dividend, and this is why a ratio of FCF(ps) to Dividend(ps) might be seen as a better reflection on the sustainability of any given dividend payout, rather then the more basic profit-related dividend-cover.

This highlights why FCF has been of interest to HYP-type income-seekers over the years. It's a little more time-consuming to clarify, but does paint a better picture when we're trying to avoid the next 'income-shock' HYP stock...

This also neatly highlights why people might feel a little uppity when they're being told they're 'ignoring the financials' if they're involved with a HYP-type strategy, but we'll leave that one there now, I think...

Cheers,

Itsallaguess

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Re: Free cash flow, it's applications and how they are calculated

#142454

Postby Melanie » May 31st, 2018, 7:16 am

simoan wrote:Matt,

OK. I've just sussed the difference is caused by adding in net borrowing of £135m to get the FCFe figure. I've never seen that done before and even the Wiki page you linked to calls it the Alternative method. I'll stick to the traditional method which is consistent with Sharepad and Phil Oakley's calculation described in P48 of his book. As I've said before, decide on your own method and stick to it, the only rule if you're going to use a ratio for comparison is to be consistent in how you calculate it!

All the best, Si

Hi Simon,

I read a little more of Phil's book last night. In the "Advanced Cash Flow analysis" section, there is a subsection, I can't remember it's exact name, but it's something along the lines of "When FCF figures are not what they seem to be".

Basically "British Land" is used as an example, and in this, when using the more "orthodox" FCF/FCFE calculation method (whatever that is!!) the figures for "Assets sold" in the CF Investing section are ignored and very low figures result! But apparently the firm is able to generate dividends. If the calculation is repeated but this time includes Assets sales (obv. boosting the cash) then the resulting figure is a lot higher.

This very point emphasises the true nature of my original query in this topic:

viewtopic.php?p=141684#p141684

i.e. why in Phils original worked example he misses some figures and includes others. (And FWIW why other online sources differ from each other). It's a real shame that he didn't start off any discussion of FCF with a full review of how different figures may or may not to be used, and how a user of such a figure really needs to be very aware of the exact nature of the sum. (BTW I'm not planning this topic to be a book review in disguise!).

So anyway - my own conclusion - calculation of these figures by private investor is wise - and in particular should include two or more attempts including or excluding other cash inputs/outputs e.g. asset sales or additional borrowing, with clear understanding as to why the answers may vary.

Matt

simoan
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Re: Free cash flow, it's applications and how they are calculated

#142512

Postby simoan » May 31st, 2018, 11:00 am

Melanie wrote:So anyway - my own conclusion - calculation of these figures by private investor is wise - and in particular should include two or more attempts including or excluding other cash inputs/outputs e.g. asset sales or additional borrowing, with clear understanding as to why the answers may vary.

Matt

My own personal approach is that analysing cashflow is not worthwhile for all companies. Particularly asset plays such as property companies. Cashflow is not the main reason to invest in these companies which are valued mostly on their net asset value and normally trade at a discount to them. This is why they often look very expensive if you use traditional valuation metrics e.g. PER. In particular, a REIT like British Land has to pay out nearly all of it's earnings as dividends to qualify as a REIT, so cashflow conversion and whether the dividend is covered by FCF is pretty irrelevant.

You just need to find an approach to calculating FCF that works for you and stick to it. As you have seen, there are a number of variations on the theme, and once you start adjusting things further based on the type of company you're looking at as Phil suggests in his book, then IMHO you're only one step from disappearing into the weeds :-)

All the best, Si

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Re: Free cash flow, it's applications and how they are calculated

#148756

Postby cshfool » June 29th, 2018, 8:36 am

Interesting thread, this one and a useful book seems to mirror the Terry Smith approach.
csh

Melanie
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Re: Free cash flow, it's applications and how they are calculated

#148787

Postby Melanie » June 29th, 2018, 11:00 am

Hi cshfool,

cshfool wrote:a useful book

Do you mean the Phil Oakley book?

cshfool wrote:seems to mirror the Terry Smith approach

Can you humour me, and elaborate on this please? :)

Is there any accompanying book or online information you can refer us to? We are keen to learn more in this and other areas (e.g. of company and share valuation).

M&M

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Re: Free cash flow, it's applications and how they are calculated

#149673

Postby Melanie » July 3rd, 2018, 12:39 pm

I have not really posted much about company/share valuation techniques just lately, though I'm still working at it from time to time. I kind of side-tracked myself by spending quite a while trying to puzzle over debt measuring/assessing techniques, and also a further distraction was provided by my recent purchase of

https://www.amazon.co.uk/Accounts-Demys ... 1292084847

which I found to be excellent, and the penny relating to double-entry bookkeeping, and the relationship between the balance sheet, the P&L statement and the Cash flow statement has pretty much dropped.

So I've been using some of the knowledge gleaned to refine my generic company valuation spreadsheet, and another question popped up in my mind, yes some may find it a bit abstract, but here goes...

What is the difference between "Cash flow" and "Free cash flow"? I'm assuming that there is one, else we'd not have the different terms. I'm clueless as to what it would be......but I'd love to hear some ideas, since it might help me get my head around, why some measurement parameters may be of use, and others not so.

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Re: Free cash flow, it's applications and how they are calculated

#149824

Postby dspp » July 3rd, 2018, 9:51 pm

OCF - (reqd) capex - interest

i.e. there is more than one cash flow measure and in a sense this is the purest

see https://en.wikipedia.org/wiki/Free_cash_flow

regards, dspp

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Re: Free cash flow, it's applications and how they are calculated

#150000

Postby Melanie » July 4th, 2018, 2:48 pm

dspp wrote:OCF - (reqd) capex - interest

i.e. there is more than one cash flow measure and in a sense this is the purest

see https://en.wikipedia.org/wiki/Free_cash_flow

regards, dspp

Yes, thanks dspp,

I have glimpsed that wiki before, but after your post I've just spent some more time rereading it, and trying to understand it again! Whilst it's potentially useful to read and compare the plethora of definitions for FCFF; however for me, I'm currently focused on taking the minimum number of entries from a typical reports PDF and lobbing them in a spreadsheet. So obviously the ones which contain the same keywords are the ones which interest me the most.

Any formulae with (1 - t) terms or (1 - d) just muddy things more for me, since both effective tax rate and d/e ratio add another level of complexity onto an analysis sheet.

(As an aside, since we've started our companies/corporate/accounting research, what I also marvel at, is the amount of different applications of the word "net". Until recently this just meant less tax, in my case, income tax and NI! However in the forementioned context, it clearly means a summation of several quantities, where some are +ve , some -ve accordingly e.g. debt and cash, interest received/paid etc.)

I believe, for my usage, in a spread sheet, that this formula is the most useful:

FCFF = After tax operating income + Noncash charges (such as D&A) - CAPEX - Working capital expenditures

since I see these three parameters, "After tax operating income", "Noncash charges (such as D&A)", "Working capital expenditures" as being typically scooped up in most Cash flow statements I've read as

Net cash from operating activities (anyone agree??)

and "Capex" being easy to tease out from the next section.

Finally, I notice the wiki also touches on FCFE, as given as:

FCFE = FCFF + Net borrowing - Interest*(1-t)

But the final terms "Net borrowing - Interest*(1-t)" blow my mind - both conceptually and in practice (i.e. in terms of extraction from a CSF).

So far for my own purposes, to derive FCFE from FCFF, I merely subtract the Interest paid and add the Interest received values - i.e. those found, typically in the final, financing, section of the CSF. (Which FWIW I assume are inclusive of taxation).

Thoughts, comments welcome.

(to be continued)

Matt

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Re: Free cash flow, it's applications and how they are calculated

#150090

Postby Melanie » July 5th, 2018, 9:05 am

So I'm trying to understand more about one of the statements in https://en.wikipedia.org/wiki/Free_cash_flow .

That is:

FCFE = FCFF + Net borrowing - Interest*(1-t)

as I said in my last it is this expression that I'm struggled over the concept of:

Net borrowing - Interest*(1-t)

I'm going to try to think of a real life example over the course of a year, and put in some numbers, and then compute the result and try to interpret it.

So I assuming that a firm borrows 500 (cash inflow), returns 200 (cash outflow), and they pay an interest rate of 10% and their tax rate is 20%.

This would mean that their net borrowings is an overall inflow i.e. 300.

To find the tax reduced interest charge (i.e. the last term in the expression), I assume that the interest contribution is only relevant to the money they have borrowed (not that they have returned over the year). So...

500 x (0.10) = 50, then 50 x (1 - 0.20) = 40.

Hence the monies added back to FCFF to derive FCFE is 300 - 40 = 260.

How does this sound?

Matt

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Re: Free cash flow, it's applications and how they are calculated

#150686

Postby cshfool » July 7th, 2018, 10:10 am

Hi M&M -

Yes correct I mean the Phil Oakley book, which I'm working through, partly based on your useful notes here. A very interesting read, though there do seem to be some slightly annoying typo/ inconsistencies for the forensically inclined reader seeking to do their own sums, eg compare the Doms 2015 change in working capital pg 45 of 6.4 with the 2015 change in working capital of 10.7 pg 52- the issue seems to be the 4.4 provisions. Despite that he gets the same bottom line Cash from operations of 80.4 so some typos going on, possibly to do with the publication process. Nevertheless some good stuff here as far as I can tell, and an interesting and new voice.

I was previously impressed by Phils identification of Carillion (see Investors Chronicle, March 10, 2017) as a value trap likely to implement a substantial cut in its dividend based on FCF, doubtful EPS growth through acquisition, pension liabilities etc. prior to final implosion. I identified CLLN as a sell here based on my own meagre workings from other directions, (with a gang of shorting hedge funds admittedly) but its nice to find another thinking black sheep.

Check out Terrys "Fundsmith" site and some of his vids at his annual backslap, his "Accounting for growth" book is worth a look too.

thanks for your worked contributions (the detailed calculations are helpful) and for pointing to this book,

csh

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Re: Free cash flow, it's applications and how they are calculated

#150692

Postby Melanie » July 7th, 2018, 10:45 am

cshfool wrote:Yes correct I mean the Phil Oakley book, which I'm working through, partly based on your useful notes here. A very interesting read, though there do seem to be some slightly annoying typo/ inconsistencies for the forensically inclined reader seeking to do their own sums, eg compare the Doms 2015 change in working capital pg 45 of 6.4 with the 2015 change in working capital of 10.7 pg 52- the issue seems to be the 4.4 provisions. Despite that he gets the same bottom line Cash from operations of 80.4 so some typos going on, possibly to do with the publication process. Nevertheless some good stuff here as far as I can tell, and an interesting and new voice.

I think it's a decent book to get started on. It's a shame about the typos....I also hate to advance further in a book until I'm quite sure about the strength of any arguments so far.

I personally would like to see a whole book (reasonably priced!) just on cash flow. Why? Well according to a great deal of analysts/professional investors "Cash is King", and (apparently) it is foolish to overly hype big (rising etc.) profits over and above that of cash. That being the case I'm surprised that more fuss is not made over an easier way to derive FCFF and FCFE . For example on forums such as this one! :lol:

I do have a mite of cynicism regarms Phils book however; I believe that it also serves as a plug for ShareScope, which is his paid subscribe-to-service.....it's almost as if the stuff in the book is a teaser for other things. Fair enough, guys got to make a living, but that's my tuppence worth.

cshfool wrote:Check out Terrys "Fundsmith" site and some of his vids at his annual backslap, his "Accounting for growth" book is worth a look too.

Thanks - will do. I'm currently reading (2 and half chapters in) "Invest in the best" (Ashworth-Lord). It seems good so far, he claims to be of a kinda Buffet mindset, and he already punctuates cash and ROCE. I also just read "Accounting demystified" (Rice) - he gives a brilliant treatment (IMO) of the balance sheet, and subsequently the relationship between it and the Cash flow + P&L statements.

Matt

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Re: Free cash flow, it's applications and how they are calculated

#150696

Postby Dod101 » July 7th, 2018, 10:56 am

Melanie wrote:
I personally would like to see a whole book (reasonably priced!) just on cash flow. Why? Well according to a great deal of analysts/professional investors "Cash is King", and (apparently) it is foolish to overly hype big (rising etc.) profits over and above that of cash. That being the case I'm surprised that more fuss is not made over an easier way to derive FCFF and FCFE . For example on forums such as this one! :lol:


The answer to that is I think that there are so many other things that are at least as important as cash flow, although I suppose we could argue that nothing Is more important. Of coursed this is the sort of thing that any Finance Director must keep an eye on, and if you can trust him to do that you don't have to!

For me what I want to see is that reported profits are more or less equal to free cash flow over time but I do not get very hung up on it and I certainly do not automatically check on it before I buy any share.

Dod

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Re: Free cash flow, it's applications and how they are calculated

#150700

Postby Melanie » July 7th, 2018, 11:02 am

Dod101 wrote:For me what I want to see is that reported profits are more or less equal to free cash flow over time but I do not get very hung up on it and I certainly do not automatically check on it before I buy any share.
Dod


Ok.... so taking an AR, what do you mean by reported profits? EBIT, EBITDA, profits before tax, profits after tax....I'm guessing that you must mean PAT for any relevance to cash.

And "free cash flow". How do you calculate that from the fin. stmts of an AR?

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Re: Free cash flow, it's applications and how they are calculated

#150704

Postby Melanie » July 7th, 2018, 11:16 am

Since I started this particular topic we've devised a spreadsheet where you can lob in some of the numbers from the fin. statements from ARs, and (hopefully!) calculate useful parameters.

Been applying this to a couple of prospective buys. Just applied to Spirax-sarco, looked alright 2014-2016, but seems that the numbers go south from 2017 (some acquisitions diluting value, in my incredibly naive/newbie opin).

I'm now looking at MicroFocus (but already v. dubious).

But regardless, I'm again puzzling over cash flow statement matters. If you are interested you can go to https://investors.microfocus.com/invest ... l-reports/ and check out the 2014 AR, which I'm currently on. So on page 70, we have:

Cash flows from operating activities
==============================
...
Interest paid (5,752)
...

Cash flows from investing activities
==============================
...
Interest received 317
...


So given the above, then according to POs book to derive FCFE from FCFF, we merely subtract the net of the paid/recv figure i.e. about 5,400?

However further down the same page, we see:

Cash flows from financing activities
==============================
...
Repayment of bank borrowings (134,000)
Proceeds from bank borrowings 215,000
Bank loan costs (5,248)
...


So now I thinking that I should just completely disregard Phil's teachings! ( :lol: ). Surely the net effect of bank borrowings should also be accounted for in the FCFE? (Phil Oakley omits Doms 16.3 repayment on pg 45, he does not even bat an eyelid as to it's significance). But surely these all cash flows in and out. Why are they arbitrarily neglected from the FCFps and FCFE calculations?

Additionally....I can't fathom out why MCRO include a line for Interest paid (5752) and one for bank loan costs (5,248). Perhaps I'm being naive, but surely they are the same?


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