Cash Flow Statements and Value Investing

Use these statements to pick good stocks to invest in!

Cash flow statements, or statements of cash flow, provide the best measure of the flow of cash into and out of a company for a particular time period.

This time period corresponds to the time period of the income statement and has the same ending date as the balance sheet statement.

Cash flow statements measure the cash flow of three different company activities.

These include ...

  • operating activities section measures the cash flow that went into and out of the company from day-to-day activities of the business
  • investing activities section measures the cash flow generated from the purchases and sales of assets, investment in plant and equipment and other line items These are the capital expenditures or capex
  • financial activities section measures the activity of cash to finance the company operations, including payment of dividends, proceeds from share issues, and proceeds of borrowings and repayment of borrowings
The term that allows the identification of a 'cash cow' or cash flow business is free cash flow. 'Cash cows' are companies with strong free cash flows.

Calculate free cash flow by subtracting 'capital expenditures' from 'net cash flows from operating activities'.

Free cash flow can also be derived by subtracting 'capex per share' from 'cash flow per share'.

Free cash flow tells you how much cash actually flows to the bottom line.

Discounted cash flow analysis (DCF) is valuation method used to estimate the attractiveness of an investment opportunity.

The DCF analysis uses future free cash flow projections and discounts them, commonly using the weighted average cost of capital, to arrive at a present value, which is used to evaluate the potential for investment.

If the intrinsic value per share of the company arrived at through DCF analysis is higher than the current share price, the opportunity to purchase may be a good one.

There are a number of discounted cash flow models available, some of which attempt to simplify the calculation.

See the discussion in the stock fair value section.

To Conclude ...

Cash flow is the life blood of any business as it allows for future attractive acquisitions without resorting to debt. It also provides a bulwark against unforeseen company mishaps.

From a value investing perspective, free cash flow is a figure that value investors like me keep a close eye on.

Return from Cash Flow Statements to Analyzing Financial Statements

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