Free cash flow is an important measure for a value investor. A company that can generate positive free cash flow will be able to fund operations moving forwards, pay their dividends, do not rely on debt and best of all will not declare bankruptcy or be in financial health.
The common FCF formula is:
Cash from operations - Capital expenditure
Once you know the FCF you can then find the Price to FCF ratio by the following
Market Cap / FCF
I like the P/FCF measure because not only is it overlooked but it provides a unique view into how cheap a company really is. Since FCF represents the cash that a company is able to generate after spending money to maintain or expand its asset base, FCF a much better "earnings" guide than plain old EPS that can be manipulated by accounting tricks.
If Wall Street focuses on PE as a measuring stick for cheapness, than P/FCF is the measuring stick for value investors.
As an example, look at some of these companies
Ticker P/E P/FCF
IBM 12.5 12
PFE 11.72 7.6
JNJ 12.5 16.9
As you can see, IBM, PFE and JNJ are great investments but PFE being the exception, IBM and JNJ are selling for over 10x FCF.
5 Mispriced Stocks Based on P/FCF
Name Ticker P/E P/FCF
Boise BZ 3.4 1.34
Central Garden & Pet Co CENT 9.6 2.8
Micron Technology MU 5.8 4
Collective Brands PSS 10.2 4.85
Signet Jewelers SIG 12.7 5.22
The above 5 stocks all cheap based on P/FCF. Boise current market value is just a little more than its FCF. These stocks are much smaller in comparison to the giants of IBM, PFE and JNJ but certainly worth a closer look.
Disclosure None
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