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Tips For Using Free Cash Flow in Your Investment Analysis

By Motley Fool Staff – Sep 28, 2016 at 2:45PM

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How an investor can use free cash flow to decide whether or not to buy into a company.

Free cash flow is one of the most important metrics for investors to understand about a company.

In this clip from Industry Focus: Energy, Motley Fool analysts Sean O'Reilly and Taylor Muckerman explain how to use free cash flow to decide whether or not a company can grow in the short and long term, or if it's just hanging on by a thread.

A full transcript follows the video.

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This podcast was recorded on Sept. 8, 2016.

Sean O'Reilly: So, free cash flow -- obviously, kind of a fictional number, especially if you're multiplying by a tax rate on something that you calculate, and all that stuff. You're an analyst for Motley Fool Canada, a stock-picking service that's about to have its three-year anniversary, congratulations.

Taylor Muckerman: Thank you, yeah, next month, October.

O'Reilly: You guys are also beating the market.

Muckerman: Yeah, we're up slightly, we're up 9.3% as of right now. The TSX is up around 9% over that time. So slightly beating, but beating nonetheless.

O'Reilly: The commodity toughness is probably not helping.

Muckerman: We actually escaped a lot of that because we don't recommend any oil producers, we only recommend pipeline companies and services companies.

O'Reilly: Going midstream. But, as an analyst on the stock-picking service, how do you and your team use free cash flow when you're picking stocks? Do you focus on free cash flow? Do you care?

Muckerman: Yeah, it's definitely something we focus on, one of the more highly valued things that we focus on. That's money that you're taking forward to the next year that you can then use to expand the business or return to shareholders. So, basically, that's exactly what we want out of a company: growing or returning. You would assume that growth would turn into returns further down the line. So, that's one of the main things I'm looking for, free cash flow growth year over year, or free cash flow compared to your revenues, how much of your sales are you turning into free cash flow. So, those are definitely some metrics that we focus on.

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