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Free Cash Flow
by Phil Weiss
TOWACO, NJ (Oct. 7, 1998) -- Last night, I began my look at Pfizer's (NYSE: PFE) Statement of Cash Flows, working through but not beyond "Net Cash Provided by Operating Activities." That's the most important section of the Cash-Flow statement for us. But there are two other segments of the report, and I'd like to identify and cover them broadly tonight.
The second section of the Statement of Cash Flows is called Investing Activities. Those of you that are interested in learning more about this subject should read some recent Boring Portfolio Reports or stop by the Buffettology Folder where they are currently working on a detailed valuation of one of the stocks in our portfolio, Coca-Cola (NYSE: KO). This section, subtitled Investing Activities, is used to report amounts that are either invested by the company in its business or realized by the company from some of its investment activities.
The final section of the Statement of Cash Flows is devoted to explaining changes in cash due to Financing Activities. This includes such items as debt repayments, proceeds received from issuing debt, changes in the amount of debt, dividends paid, stock option transactions, and purchases of common stock.
The items in this section that are of critical importance to the Cash-King investor are the listings of common-stock and stock-option transactions. These can give you an idea of whether or not a company is actually following through on any announced stock buyback plans. Remember, companies announce repurchase plans of "up to $1 billion in stock," meaning that they may only repurchase $50 million. You can track their follow through in the Financing Activities section.
To close tonight's short report, I'll return to last night's column. At the end of last night's report, I declared that, with what we had, we were pretty close to an important calculation called Free Cash Flow. Although we don't talk a lot about valuation in the reports for this portfolio, there are plenty of reasons to attempt valuations. Heck, some day you may be responsible for running mergers and acquisitions at a multi-national bank! Valuation will mean something then.
So, let's look at one of the most respected valuation techniques, which revolves around free cash flow. The simplest way to define free cash flow is to add net income to all non-cash expenses, such as depreciation and amortization, and then subtract out all capital expenditures. More precise definitions of free cash flow exist, but I'll save those for our message folder discussion. To work valuations here, just take the company's capitalization and divide it by its total free cash flow -- you'll get a picture of how richly-valued companies are relative to their competitors. And that'll be based on a true reflection of the cash in a business -- the sort of focus we like here in the land of Cash-Kings.
If you have any questions on anything covered during last two night's reports, please post them to our Cash-King Strategies Folder.
Fool on!
Phil Weiss
Cash-King Strategy Folder
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