Here's why Oracle
In the daily noise machine of CNBC, analyst estimates, and quarterly announcements, investors are inundated with talking heads obsessing over earnings-per-share figures.
Earnings, or net income, is an accounting construction that is the basis for the price-to-earnings ratio, the most popular way of measuring how cheap or expensive a stock is.
But free cash flow -- the amount of cash a company earns on its operations minus what it spends on them -- is another, oftentimes more accurate measure of earnings that can give you an advantage.
How Oracle stacks up
If Oracle tends to generate more free cash flow than net income, there's a good chance earnings-per-share figures understate its profitability and overstate its price tag. Conversely, if Ford consistently generates less free cash flow than net income, it may be less profitable and more expensive than it appears.
This graph compares Oracle's historical net income to free cash flow. (I omitted various gains and charges such as tax deferrals, restructurings, and benefits related to stock options.)
Source: Capital IQ, a division of Standard & Poor's, and author's calculations.
As you can see, Oracle has a tendency to produce more free cash flow than net income.
This means that the standard price-to-earnings multiple investors use to judge companies may overstate its price tag.
Let's examine Oracle alongside some of its peers for additional context:
Company |
Price-to-Earnings Ratio |
Price-to-Free-Cash-Flow Ratio |
---|---|---|
Oracle |
19.0 |
14.1 |
VMware |
140.6 |
61.1 |
Symantec |
14.2 |
7.5 |
IBM |
12.1 |
9.9 |
We can see that it's not unusual for these companies to be cheaper on a free cash flow basis; VMware, Symantec, and IBM all have lower multiples when we consider the cash they generate. It's incredible to see just how much cheaper these companies are on a free cash flow basis.
In Oracle's case, the disparity is largely owed to the fact that it records huge non-cash amortization charges from previous acquisitions on its reported income statement. Oracle's free cash flow multiple suggests it is much cheaper than many investors think.