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How to Use Leveraged Free Cash Flow to Analyze Stocks
52 comments | February 14, 2011 | includes: CRM, CSCO, GOOG, JNPR, MSFT, NEM, NFLX, SIRI
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Give a man a fish and you feed him for a day. Teach a man to fish and you feed him for a lifetime.
Since introducing my research system to Seeking Alpha’s readership, I have gotten a lot of positive feedback. Many have asked me how they can get access to the data I use to analyze stocks. I have already taught everyone how to use my Statistical Indicator Analysis (SIA) here:
So one of my four methods of analyzing stocks can be easily emulated and I even provide a free spreadsheet, for anyone who wants to try it on their own.
Unfortunately, this analysis requires that one have historical cash flow and capital expenditure data going back at least 20 years, which is not available to the average investor, as I had to create my own proprietary database from scratch. Over time I will continue to write articles on individual stocks and release my data one stock at a time, but since I am an Investment Advisor, I reserve my proprietary database, strictly to use for picking stocks for my clients.
What I will do though is give you a “back of the envelope” method, which is nowhere as complete as my system is, but nevertheless can assist the individual investor to analyze a stock in a little over a minute and with this one calculation, investors can go a long way in protecting themselves from making mistakes. It can also allow the individual investor to quickly review the portfolios of their own investment advisors or stock brokers and see if they are investing their assets properly for them. Again this is just a short cut, back of the envelope calculation but can go a long way in helping the individual investor preserve their capital and reduce the risk of overpaying.
So here it is:
Levered Free Cash Flow = Cash Flow from Operations – Capital Expenditures
The Levered Free Cash Flow shows you the amount of cash available to pay shareholders after it has paid its debt. It can be a very important figure.
The formula looks like this
(Cash flow from operations) – (Capital expenditures)
This number is very important because unlike earnings or income statements, which can be easily tweaked, it is very hard to manipulate cash flow. It is also important because the amount of cash a company has after paying its bills can be used to help make shareholders money. For example, a company can use earnings to reinvest in the company and/or to give out money to shareholders as dividends. If a company does have a high levered free cash flow it is best to find one that pays out dividends as well as reinvests in itself. You do not want to invest in a company that has lots of cash flow but foolishly spends it.
For those of you who have been following my work on Seeking Alpha, you will notice that the Levered Free Cash Flow ratio is just another name for Warren Buffett’s “Owner Earnings” formula, which is Cash Flow from Operations – Capital Expenditures. That same formula is the basis of my Price to Owner Earnings (P/OE) formula that I use in my writings.
Now for the good news!
Yahoo Finance, besides being kind enough to provide us with historical price action for stocks, also provides us with Levered Free Cash Flow for thousands of companies and it’s free for anyone to use.
All you need to do is go to this page:
(Please bookmark it as it will be your main page for this analysis from now on)
In about a minute you can do a “back of the envelope” quick calculation of Apple (AAPL) and know where you stand.
Let us Begin:
On that page if you go to the very bottom of the table you will see under Cash Flow Statement:
Levered Free Cash Flow (TTM) = $13.88
This basically means that over the last trailing twelve months that Apple has generated $13.88 Billion in Owner Earnings or Levered Free Cash Flow. So we now have that number, but how does it help us?
Well the next step is to move to the right of the table where you will find under “Share Statistics” the number for Shares Outstanding. Apple’s shares outstanding (TTM) = 921.8 million.
Therefore we have all the data we need and the calculation becomes an easy one;
$13880/921 = $15.07 per share.
So we then take Apple’s 2/11/2011 closing price of $356.85 and divide that by $15.07 and we get 23.68.
Thus Apple is trading at 23.68 times its Levered Free Cash Flow (Owner Earnings). If you return to my website page you will be able to download my “60 year backtest of Owner Earnings.”
After reading my historical backtest you will see that I have proved that anyone buying stocks selling for 15 times or less a company’s price to levered free cash flow would have done very well over the last 60 years, putting up results close to what Warren Buffett has achieved, which is only logical as he is the creator of the “Owner Earnings” ratio.
Being a conservative investor I like to buy at less than 15 times and sell always at 30 times regardless of the prospects of the company. But that is just how I do it and you can tweak it depending on your own tolerance for risk. Also remember that these are trailing numbers and not forward numbers and I like to go out one year in the future and analyze Owner Earnings for 2011 and then base my calculations on those results. But this as we said is just a short “back of the envelope” calculation to help you avoid overpaying on overbought stocks. To go out to 2011 you need to buy additional research such as Value Line.
So this back of the envelope method, in the end becomes a very powerful tool for the individual investor in its ability to allow such an investor to quickly analyze his or her portfolio. It can also analyze the portfolio that the investor's investment advisor or broker has put the investor in and not only that, but ETF and Mutual Fund holdings can also be quickly analyzed using this method. So for those of you trapped in employee retirement programs that require you to invest in only a select group of mutual funds, you can now compare each fund's holdings and see which is the more attractive option for you.
Always remember that this method is just a first step in analyzing a company and requires the investor to also read a company’s annual reports and maybe do an SIA as well. There are also qualitative risks that must be factored in such as in Apple’s case, the health of Steve Jobs for example or the ability of Steve Ballmer as CEO of Microsoft (MSFT) to take the company where it needs to go etc... So there is no one shot magic formula for picking stocks, but using Levered Free Cash Flow and SIA, where the data is free to the individual investor through Yahoo Finance, can go a long way in protecting an individual investor from overpaying, not to mention how it can protect them from investing in the wrong stock tips that they may get from a friend or from Jim Cramer.
As I have calculated Apple’s numbers for you, I thought it would be good to show you the results of a few more highly popular companies, so you can see if you are doing your calculations correctly.
So here they are:
Salesforce.com (CRM)
Levered Free Cash Flow = $316 million
Shares Outstanding = 131.40 million
Owner Earnings per share = 316/131.40 = $2.40
2/11/2011 closing price = $141.51
Price to Owner Earnings = $141.51/$2.40 = 58.96
Netflix (NFLX)
Levered Free Cash Flow = $320.62 million
Shares Outstanding = 52.78 million
Owner Earnings per share = 320.62/52.78 = $6.07
2/11/2011 closing price = $231.07
Price to Owner Earnings = $231.07/$6.07 = 38.06
Cisco Systems (CSCO)
Levered Free Cash Flow = $6.17 Billion
Shares Outstanding = 5.54 billion
Owner Earnings per share = 6.17/5.54 = $1.11
2/11/2011 closing price = $18.70
Price to Owner Earnings = $18.70/$1.11 = 16.84
Juniper Networks (JNPR)
Levered Free Cash Flow = $332.39 million
Shares Outstanding = 523.56 million
Owner Earnings per share = 332.39/523.56 = $0.63
2/11/2011 closing price = $43.41
Price to Owner Earnings = $43.41/$0.63 = 68.90
Sirius XM Radio (SIRI)
Levered Free Cash Flow = $231.14 million
Shares Outstanding = 3.93 billion
Owner Earnings per share = 231.14/3930 = $0.058
2/11/2011 closing price = $1.84
Price to Owner Earnings = $1.84/$0.058= 31.72
Microsoft (MSFT)
Levered Free Cash Flow = $17.55 Billion
Shares Outstanding = 8.40 billion
Owner Earnings per share = 17.55/8.40= $2.08
2/11/2011 closing price = $27.25
Price to Owner Earnings = $27.25/$2.08= 13.10
Google (GOOG)
Levered Free Cash Flow = $5.74 Billion
Shares Outstanding = 319.94 million
Owner Earnings per share = 5740/319.94= $17.94
2/11/2011 closing price = $624.50
Price to Owner Earnings = $624.50/$17.94= 34.81
Newmont Mining (NEM)
Levered Free Cash Flow = $1.48 Billion
Shares Outstanding = 493.06 million
Owner Earnings per share = 1480/493.06= $3.00
2/11/2011 closing price = $56.88
Price to Owner Earnings = $56.88/$3= 18.96
There you have it, a quick and easy test of your holdings based on a ratio that Buffett introduced to the world in 1986 - one that I have done a 60-year backtest of the DJIA on (1950-2009) to prove its validity. Please remember to always do your own “Due Diligence” and try to practice “Capital Appreciation through Capital Preservation.” Never buy a stock or act on a tip without doing your own analysis first. More people lose money from stock tips then from any other method I know, so the best tip I can give you is to never buy stock tips.
Disclosure: I am long CSCO, MSFT, GOOG.
Additional disclosure: No position in the others
Disclaimer: Always remember that these are the results of our research based on the methodology that I have outlined above and in other articles previously published. This research is provided as an educational tool and should not be considered investment advice, but just the results of our research. There are many ways to analyze a stock and you should never blindly follow anyone’s work without doing your own due diligence or by seeking the help of an investment advisor, if you so need one. As Registered Investment Advisors, we see it as our responsibility to advise the following: We take our research seriously, we do our best to get it right, and we “eat our own cooking,” but we could be wrong. Please note, investments involve risk and unless otherwise stated, are not guaranteed. Past performance cannot be used as an indicator to determine future results. Strategies mentioned may not be suitable for everyone. We do not know your personal financial situation, so the information contained in this communiqué represents the opinions of Peter “Mycroft” Psaras, and should not be construed as personalized investment advice. Information expressed does not take into account your specific situation or objectives, and is not intended as recommendations appropriate for you. Before acting on any information mentioned, it is recommended to seek advice from a qualified tax or investment adviser to determine whether it is suitable for your specific situation.
This article is tagged with: United States
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Comments (52)
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valuestocksonlyComments (293)
Wow! You have worked as an investor for family and friends. I am IMPRESSED! 14 Feb, 10:08 AM0
clipit89Comments (17)
As one of his friends I am INDEED IMPRESSED. 14 Feb, 10:33 AM9
RaiComments (53)
I also crowned FCF as my most important metric and have read your 60-year backtest for the first time.
I was very impressed that a seemingly easy criterion (FCF) can produce such an amazing outperformance over time which would make Buffett himself proud.
The only criticism I would have is, that since you are picking your stocks every year, that you might also get "one hit wonders". Another thing would be that sometimes your yearly portfolio sometimes only consists of a few names.
But of course I understand that your article and paper is for proving your thesis (mechanically) and would differ from real world.
Thanks a lot Peter for another well written article with analysis to back it up! 14 Feb, 11:35 AM3
Peter Mycroft PsarasComments (372)
Thanks RAI,
Since the back-test was only concentrated in 30 stocks, we did get some years where we did have one hit wonders, but I am sure if someone back-tests the S&P 500 they would find many good buys every year. One of your fellow Seeking Alpha readers Jack came up with an interesting discovery about my back-test and I wrote about it here:
seekingalpha.com/artic...
Mycroft 14 Feb, 11:55 AM0
grangerComments (2158)
Outstanding, thank you
I realize Buffett would never use this to look at the market as a whole, but have you ever extrapolated this out to say the S&P 500 as a snapshot?
Is it possible?
does the data exist? where?
(short of doing it individually for all S&P 500 comapnies individually)
Thanks for your thoughts 14 Feb, 12:26 PM0
Peter Mycroft PsarasComments (372)
Hi Granger,
It took me six months of working 8 hours a day to complete the current back-test. I also had to work in the Seattle Public Library as that is the only place I know of that has the data going back to 1950. I tried to buy the data from Value Line to work on the S&P 500 Index, but there is no way for them to sell it to me as it is in their archives. I think it would take a team of a dozen analysts over a year to pull it off. I think only S&P could do it but it would cost them a fortune in man hours to do it. Someday I hope someone does it, but I no longer have the time as I am an Investment Advisor now, as well as an Analyst so my plate is full.
Mycroft 14 Feb, 12:35 PM0
grangerComments (2158)
Also, interesting to see the valuation on some of these firms
I have been spot checking comapnies all morning long, very eye opening 14 Feb, 12:29 PM0
Peter Mycroft PsarasComments (372)
Thanks Granger,
What you are doing is what I am hoping that all investors will do, as the numbers don't lie. If I can just get this message out, that there is a way to check stock tips or what Cramer tells you and see if he is right or not.
Just a minute a stock is all that is needed and its all free on Yahoo Finance. The little guy doesn't stand a chance against the press, CNBC, Flash Traders and Goldman Sachs, but with this one minute test we can even the playing field instantly and not be taken in by the tons of bad research that is pumped and dumped on the individual investor everyday. Imagine if people learn that they can use this simple test to analyze their mutual funds or ETF'S.
I say power to the people and no one can argue with the test as Warren Buffett created it. So Enjoy everyone and practice Capital Appreciation through Capital Preservation.
Mycroft 14 Feb, 12:50 PM0
jimmy46Comments (1148)
So according to your simplistic theory,
stocks like
PBR which has a LFCF of minus $25 Billion
and CHK ............ " ... of minus $4 Billion
Must be terrible investments, yes?
Or are you forgetting that most companies are investing in future growth?
And how do you tell how much of the capital ex is used to maintain the business,
and how much to grow it? 14 Feb, 02:16 PM0
Peter Mycroft PsarasComments (372)
I would not say they are terrible investments, but I just want people to know that they have negative free cash flow and any business that runs on negative free cash flow for too long could end up being a terrible investment. I would have you take those same companies and run my FROIC analysis on them as well.
Free Cash Flow / Invested Capital
free cash flow / shareholders equity + long term debt
So if they are investing so heavily that they are achieving negative returns for every dollar of invested capital then you have troubles.
There are a million ways to invest and I just want everyone to be aware of free cash flow as it is the most powerful financial tool that I know of.
Thanks for posting,
Mycroft 14 Feb, 03:21 PM0
Peter Mycroft PsarasComments (372)
SIA is used as part of a three step system. I have not analyzed SIRI using my system as its COE would have resulted in an extreme negative reading that would have neutralized the SIA you are talking about. Just like JDSU, when you have a stock that drops out of bed like these stocks have, you need to be very careful as they could go out of business in a millisecond. Had John Malone not come to the rescue SIRI would have been sold off in a banckruptcy. Today SIRI is cash flow positive but since 1994 it has been a terrible investment and my system does not work well when you have decades of negative free cash flow. Since 1994 SIRI has lost $-32.28 in free cash flow per share. So when you use SIA remember that if the company is doing terrible on Main Street then it will show up cockeyed on the SIA chart. Palm for example went from $200 down to $1 and JDSU went all the way from $1728 to $2 so you can't analyze such insane investor sentiment. SIA works great on 99% of the companies it analyzes but Palm, SIRI, and JDSU are impossible to analyze using any system as they are pure investment sentiment stocks. 14 Feb, 04:58 PM0
Peter Mycroft PsarasComments (372)
Just click on my profile and it will take you to all my articles.
Mycroft 14 Feb, 05:43 PM0
chrlsboone@yahoo.comComments (129)
Wht is your opinion of siri stock? 14 Feb, 09:14 PM0
Peter Mycroft PsarasComments (372)
Hi Chris,
I am a loyal customer using their service through the internet and in two cars. I think it is one of the most amazing products ever created but as for the stock, I am a very conservative investor and don't like roller coasters. I try to make 15% a year on average for my customers and double their money every 5 years, so I am not interested in taking big risks. What management needs to do is a reverse split and issue 1 share for every 30 and stop paying guys like Howard Stern millions of shares as that dilutes the shareholders stake unless you can lock him in for 5 years and not allow him to sell.
Vonage, Sirius and Sprint are all great companies but they need to bring some sanity to their shares and reduce the roller coaster effect. Running -$32 per share in free cash flow losses over its lifetime is not my idea of a well managed company.
I love the company's products but don't like the management as they are willing at a moments notice to issue untold amount of shares at will and that's dangerous. Berkshire Hathaway's stock sells for what it does as it only has 1.3 million shares. Doing a reverse split would do wonders, but I don't see that happening.
Mycroft 14 Feb, 09:46 PM0
igggyComments (380)
Mycroft,
Would you apply this analysis to retail stocks? TGT, RSH, BBY all look cheap provided they can sustain their performance in the future.
Also, what do you think about Greenblat's magic formula. It looks like a more advanced version of your analysis but I might be wrong.
Thank you. 15 Feb, 03:24 AM0
Peter Mycroft PsarasComments (372)
Igggy,
The whole idea behind this article is for you to analyze the three stocks you mentioned and not to rely on others. Go do them, post them here and then I will check them for you to see if you are right.
First, there is no such thing as a magic formula on Wall Street. There are just tools that you can use to make you successful. The only magic formula that I know of is the one Thomas Edison came up with which is:
"Genius is one percent inspiration, ninety-nine percent perspiration"
Having said that I do admire Mr. Greenblat and take my hat off to anyone who tries to even the playing field for the individual investor.
Looking forward to your analysis,
Mycroft 15 Feb, 06:16 AM0
Mr. GanComments (5)
I have been using this method for a while.
So according to owner's value calculation,
Radio Shack is worth investing,
price at 15.67
levered FCF:192.62M
shares outstanding: 113.82M
This gives you a ratio of 9.25
Isn't this a bargain, I think it is, I am long RSH 15 Feb, 07:07 AM0
Peter Mycroft PsarasComments (372)
Radio Shack is definitely a value play on the wireless world and allows people not living in the urban centers a chance to go to their local Radio Shack and get the same offerings that they can in a mall. Competition is fierce, but the stock has fallen 25% since November, which means that the speculators have lost interest in the stock. Which is a good thing in my book.Good Luck with it and thanks for posting.MycroftDisclosure to position in RSH 15 Feb, 07:32 AM0
The HammerComments (1519)
RE rsh has lots of goodwill and what is this goodwill worth? The free cashflow, how reliable is it? Does it really have a competitive advantage? I think not this is why i have avoided it.
RE Csco: I like to factor in stock options as an ongoing cost when calculating fcf's. They buyback billions of shares but it does not lower share count anywhere near amount spent.
Goog trades at 35 times. A great company but it appears priced in to me with little downside margin at least at this price.
NEM is the big sleeper here imo. The mining shares have been mismanaged for sometime, but this is changing. Mgt is avoiding issuing new shares to fund operations and make acquistions while their underlying commodity is priced strong (Mainly gold but some copper which can be cyclical). FCF's imo are going to get stronger. Fcf's are going to really turn up here.
Does not appear to be to much hedge fund support either. 15 Feb, 09:28 AM1
Alph1eComment (1)
Thank you for sharing this with us. I have a question. When I review your numbers and Yahoo's of Leveraged Free Cash Flow, I do not get the same numbers. For example, Yahoo states that MSFT leverage free cash flow is 17.55. TTM EBITDA of MSFT was $27,092 its TTM capex was 2,221 and if you include their R&D of 8,951 this totals 11,172. Taking that number away from 27,092 equals 15,920. If you use another Earnings before non operating income of 26,384 minus 11,172 you get 15,212. I just can seem to get to the number 17.55. Can you help? 15 Feb, 11:40 AM0
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