In the Energy business, free cash flow is one of the most important metrics you can use for analyzing companies. 

In this clip from Industry Focus: Energy, Sean O'Reilly and Taylor Muckerman look at two companies -- one with fantastic free cash flow generation over the last seven years, and one with terrible free cash flow growth in that same time.

Listen in to find out why free cash flow is so important to look at for potential investments, why it's crucial to look at the metric in context of the company's bigger picture, and how to interpret the number to get the big picture of a company's health.

A full transcript follows the video.

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This podcast was recorded on Sept. 8, 2016.

Sean O'Reilly: If I were to ask you to name a company that is awesome at generating free cash flow, what's the first one that comes to mind?

Taylor Muckerman: There's a lot of services companies out there. Right now, what you're seeing is producers that are struggling because they have high capital expenditure budgets, and now their revenue is declining and their net income is declining. So, some service companies -- one that we recommend in Stock Advisor Canada is Enerflex...

O'Reilly: You made that up.

Muckerman: No, it's traded on the Toronto Stock Exchange. Ticker EFX.

O'Reilly: I hope they do exist.

Muckerman: It's a pipeline services company. They're not a pipeline operator, but they do service pipelines. So, that's one company that's out there making money. Their capital expenditures aren't necessarily quite as high as even a pipeline company, because they're not expanding their geographic footprint. As pipelines grow, their business grows, and aging pipelines are a big business for them as well. And then, you have all three major U.S. services companies -- SchlumbergerHalliburton (HAL 0.95%), and Baker Hughes -- all ranking very highly on free cash flow generation. I'm talking right now about seven-year CAGR -- compound annual growth rate -- of free cash flow growth, and all three of those companies rank in the top deciles of the energy market.

O'Reilly: OK, so, I pulled up Halliburton. For our listeners who want to follow along, go to and type in...just kidding. 

Muckerman: Well, this is a class, right? So follow along, darn it!

O'Reilly: Follow along, Jimmy, and get to the front of the class, here. In 2015, this is on their cash flow statement, it's one of the three major statements that every company is required to --

Muckerman: Hold on, I'm clicking over. It's arguably the most important. Basically, the other two statements are dumped in it.

O'Reilly: You can see where everything is flowing.

Muckerman: You can see dividends being paid, you can see interest being paid, you can see debt being taken on or debt being repaid, and then all the income and everything right there. 

O'Reilly: So, for the class, in fiscal year 2015 -- is that OK with you, to use 2015?

Muckerman: It's the last fiscal year.

O'Reilly: Net income for Halliburton of negative $671 million.

Muckerman: What!?

O'Reilly: Oh my gosh, they lost money?!

Muckerman: I hate that business!

O'Reilly: This is terrible!

Muckerman: This is the worst business on the planet!

O'Reilly: However, you add back depreciation and amortization -- that is a non-cash charge. Their assets are aging, but this is not money out the door.

Muckerman: No, it is not.

O'Reilly: So, automatically, they're earning money again. We're adding back $1.8 billion. Got a loss there of $1.1 billion from non-operating activities, I'm not sure what that is.

Muckerman: That's going to be those one-time charges like layoffs or restructuring or asset writedowns.

O'Reilly: They probably laid off a few people last year, you're right.

Muckerman: They did, unfortunately.

O'Reilly: Changes in accounts receivable. That went up by $1.468 billion. Change in accounts payable, -$603 million. So, cash from operations: $2.9 billion. We're doing alright.

Muckerman: Dun dun dun-dun!

O'Reilly: And last year, they invested just $2.18 billion, so free cash flow of a little over $700 million to party with.

Muckerman: Basically flipped the script on that $671 million loss.

O'Reilly: Not too shabby.

Muckerman: Not too shabby at all.

O'Reilly: Let's rewind. Can you think of any companies that are terrible free cash flow generators, that maybe even show GAAP profits all the time?

Muckerman: Well, just to top the list, I ran the same screen -- seven-year compound annual growth rate of free cash flow growth.

O'Reilly: Who's the worst of the worst?

Muckerman: You'll never guess who's at the top of this list.

O'Reilly: For the worst?

Muckerman: For the worst. This is a negative compound annual growth rate over the last seven years for their free cash flow.

O'Reilly: And it's in our sector? Energy, materials, and industrials?

Muckerman: Yeah. It's at the top of another list, too. It's a pop quiz.

O'Reilly: Is it Chesapeake Energy?

Muckerman: No. 

O'Reilly: Aw, shoot.

Muckerman: It's Exxon (XOM 0.02%).

O'Reilly: Really?!

Muckerman: Yeah. Because they have such huge capital expenditures. Massive capital expenditures. So, when you have this flip-flop in oil prices...and, to let everybody know, seven years ago, September 2009, oil prices were in the mid-$60s. So, it's not a terribly different environment, as you remember, oil had gotten above $150 before the financial crisis, and plummeted along with the rest of the economy.

O'Reilly: Yeah, here it is. 2014, for our listeners, Exxon generated free cash flow of...$45 billion from operations, $33 billion spent, so, $12 billion. But, this last year, 2015, they generated just $3 billion in free cash flow. And the last 12 months, which includes the latest couple quarters, it's basically breaking even on a cash basis.

Muckerman: It's not negative free cash flow, but negative free cash flow growth.

O'Reilly: Oof! Exxon...and to make matters worse, they're still paying that dividend!

Muckerman: And to make matters even worse, they're not replacing 100% of their oil at the moment.

O'Reilly: Dun dun dun

Muckerman: But they're still the biggest publicly traded oil company in the world.

O'Reilly: Yeah, so they're fine. So, before we say class is dismissed and send everybody home to do their homework, do you have any final thoughts or takeaways that you might want to give everybody to think about when they're walking home?

Muckerman: Yeah. Just to show you right there, the largest oil company publicly traded here in the United States is the worst at free cash flow growth over the last seven years. But, has it been a terrible investment in the last seven years? No. The cyclicality of the oil industry can affect some figures like free cash flow, but they are still making free cash, so they're still able to return that to shareholders, or reinvest it back into the business, as we've seen with capital expenditures being, what did you say, $35 billion?

O'Reilly: Yeah, every year.

Muckerman: So, they're growing the business, or at least maintaining the business. It's not the end-all be-all factor to look at.

O'Reilly: It's a number, and you need to know the story and the reasons for the number.

Muckerman: Exactly. It's a worthwhile screen. But if your company isn't producing free cash flow, you might want to worry a little bit, unless it's a hyper-growth company in a very early stage. If it's a late-stage company, and free cash flow suddenly disappears...

O'Reilly: That's bad.

Muckerman: Then ask, why?