Free Cash Flow (FCF)
Definition
Free cash flow is the cash a company generates after accounting for the capital expenditures needed to maintain or expand its asset base. It represents the cash that could be distributed to shareholders or reinvested in the business.
Operating Cash Flow − Capital Expenditures = Free Cash FlowHow to Interpret Free Cash Flow (FCF)
Positive FCF means the company generates more cash than it needs to maintain its operations. Negative FCF means it is burning cash and may need to raise capital. We look for companies with consistently growing FCF because it is harder to manipulate than earnings and reflects real cash generation. FCF should generally track or exceed net income over long periods.
Why It Matters for Investors
Free cash flow is the foundation of shareholder value. A company can use FCF to pay dividends, buy back shares, reduce debt, or reinvest in growth. Without FCF, a company cannot sustain itself without borrowing or issuing shares. FCF yield (FCF divided by enterprise value) is our preferred valuation metric.
Frequently Asked Questions
How is FCF different from net income?
Net income includes non-cash items like depreciation and amortization. FCF shows actual cash generated. A company can report positive net income but negative FCF if its working capital is growing or its capital expenditures are high.
What is a good FCF margin?
FCF margin (FCF divided by revenue) above 10% is good for most industries. Above 20% is excellent and typical of high-quality compounders with low capital intensity.
Can a company have negative FCF and still be a good investment?
Yes, temporarily. Young companies investing heavily in growth often have negative FCF. But negative FCF cannot last forever — the company must eventually generate cash to justify its valuation.
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