A Newbie Guide to Investing

[Clement]

Thanks for your help! How is the free cash flow used to evaluate the company from that FCF/share perspective?

There is no correct answer to this type of questions. There are different methodologies applied in investment evaluation, whether earnings, book value or cash flow is used.

In general, to use fcf in valuation, the following ideas are applied.

1) Relative valuation. Compare P/fcf per share or p/e multiples to those of comparable companies or historical multiples for the same company. This uses market prices as benchmarks for valuation.

2) Absolute valuation. Traditional discounted cash flow analysis. This suffers a lot from garbage input, garbage output problems of financial modeling as many variables are unobservable and need to be estimated.

[8ALEX8]

I actually do understand the discounted earnings approach because it makes absolute sense and i can estimate whether the stock is over or under valued.

But i do not catch how the free cash flow is actually link in helping to evaluate a company. I've always seen pple doing valuation on fcf but i couldnt understand how its link to a stock valuation. And since earnings and the cash flow coming in is not literally same, there must be a meaning for the cash flow.

Anyone out there to enlighten me? Greatly appreciate it

[CityFarmer]

May be a better starting point is to read books on value investment. You may find suitable one in the forum below.

http://www.valuebuddies.com/forum-11.html

[8ALEX8]

thanks, i'll definitely read up as many books there are abt value investing.

[dzwm87]

I actually do understand the discounted earnings approach because it makes absolute sense and i can estimate whether the stock is over or under valued.

But i do not catch how the free cash flow is actually link in helping to evaluate a company. I've always seen pple doing valuation on fcf but i couldnt understand how its link to a stock valuation. And since earnings and the cash flow coming in is not literally same, there must be a meaning for the cash flow.

Anyone out there to enlighten me? Greatly appreciate it

Well, when you run a business, what's the most important thing? You definitely want a business to earn profits - not in accounting profits but in cash profits.

Why there is an importance in free cash flow is because you need to re-invest into the business. You can't possibly be collecting your operating cash flow from the business and not re-invest to sustain the business.

The best business is one which funds itself internally and generates a sizeable amount of FCF each year while the worse is the one which demands external funding every year.

[Temperament]

I actually do understand the discounted earnings approach because it makes absolute sense and i can estimate whether the stock is over or under valued.

But i do not catch how the free cash flow is actually link in helping to evaluate a company. I've always seen pple doing valuation on fcf but i couldnt understand how its link to a stock valuation. And since earnings and the cash flow coming in is not literally same, there must be a meaning for the cash flow.

Anyone out there to enlighten me? Greatly appreciate it

Very simply put if your earning(your salary) is used up more by your spending(cash-flow), you are in debt.
So you may earn $10,000/month but you spend $11000. If you carry on like this for too long, how long can you be able to find people, banks to want to lend to you. In fact you may have to declare you are bankrupt soon.
This is only a very, very simple analogy of earnings and cash flow. But it can happen to a company too. imho.

CASH FLOW is not one way traffic. The word flow means in and out, in and out. And when it is out means you have less cash lol. So if you can track accurately how the money flows, you then will know at the end of the day whether your FCF is real hard cash or cosmetics only.

[CY09]

To be honest. To understand the concept of cash flow, I am afraid you have to read up on how Property, Plant, Equipment(PPE) are accounted and expensed on accounting books, how trade receivables and payables etc work.

Applying how businesses work to the concept of an individual is a little hard as our personal life we do not have much PPE. The closest I can think of is a HDB flat with a 99 yr lease, where it is accounted for as an asset (but it dosen't contribute much to our "revenue" generating jobs). Hence 8sales, do read up on how PPE works.

[Temperament]

Yes! The more you read the more you will get "confused" (but you must persevere) until one day you see the whole picture. Then you will realised sooner or later you can understand a FCF report but i don't think you can be sure the money is hard cash or cosmetics only. i think only the business owners or insiders should/will know unless of course the company acountant is too smart for them.

[gautam]

since as the title of this post suggest, its for a newbie trying to gain footage into the world of investment,.

Expert investors need not read on if you like as you might not agree with what I am going to say subsequently:

personally, I DO NOT think FCF, EBIT, PPE etc....u can have so many different terms and each mean different and each different investor(even successful one) use different ones.

IMO, these are NOT important for the long term investors and you might be surprised how simple the concept is.

Ask yourself a simple qn. How can you make money from investing in a company?
-either stock price goes up and you sell it for a profit or you earn the dividends.

Yes, it is that simple.

Now lets move on.

If you work for someone and that someone gives you a rise of a certain percentage each year for twnety years, would you be happy?
Of course. hardly any wouldnt.

And what tells you of this boss who gives you that rise?? Simple fact: he's making more money every year.

Ok, you got it...

the same applies to company which has been in existence for decades and pays diveidends every single year without fail and in fact, raise dividends every year or at least every few years. That the company is growing and making more money over time.

Could you name any company which fit the above description and subsequently went bust? Well, I can't.

So IMO, key is not to think so much, enjoy life and enjoy investing and enjoy your money!

In summary,

1. Look into companies which pays dividends EVERY single year over the past decades and have characteristics of raising dividends.

2. And use the dividends to buy more shares.

BINGO...you are there!!!

[Temperament]

Yes it can be that simple if all you care is about "Pedigree" of an animal. But like wise you can compare the "Pedigree" of a companies. But i still think it is not 100%. As Genius to the extreme is just divided by a very thin line. Besides, anything can happen in life.-- The Truth is always stranger than Fiction.