Free Cash Flow Matters
We believe free cash flow analysis is the best way to understand a company’s economic situation and proposition as a potential investment. Accounting earnings (GAAP earnings) can be manipulated through accounting conventions, methods, estimates and so on. We prefer to study and understand how a company’s cash is sourced, allocated, expended and recaptured. We also think understanding the free cash flow metrics of a company provides valuable insights into the quality of earnings a company may or may not have. We prefer to do this over many years, however, with smaller companies, some times this is not possible and what is more important is to understand how management thinks about future investments of firm cash and resources. One of the first questions we will try to conclude on is whether or not a company will self-finance its own growth through existing operations. This means a company will expand only with internally generated funds that are the result of success in current operations (cash profits) that are reinvested to expand the business.