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ShowMeTheValue's avatar

Most of my points have already been made (CapEx is lumpy, and companies go through intense investment periods; it's important to separate maintenance CapEx from growth CapEx as a company can under-invest and generate good FCF and ROIC initially, but it's not sustainable)

I look at earnings quality and cash conversion ratio when analysing a company - over 5 to 10 years, how well does EBITDA reflect Cash Flow From Operations, how well does CFFO reflect earnings (should be better than 100% due to D&A exclusion), and how well do earnings convert into free cash flow?

Aligned with Matt's comments, I'm suspicious of a company with very high or very low earnings quality or conversion ratio much over 100% for an extended period (unless that is obviously linked to the business model)

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Tayga Vural's avatar

This is an excellent informative analysis.

I recently analyzed CrowdStrike, which reported a negative net income and appeared unprofitable. However, it had significant R&D investments that weren't accounted for, and with depreciation, this metric did not accurately reflect the company's financial performance. Upon further analysis of FCF, it became clear that this was not the case. Further taking into account cash and cash equivalents, I realized that they had a more nuanced approach to managing their profits, assets, and other key metrics.

Additionally, understanding FCF can help an investor look out for possible changes in a company. For example, if a private equity firm becomes involved, noticing that the company has healthy cash flow and free cash flow, it may conduct a reorg to try to bolster the company and drive growth. Of course, this is very specific, but it illustrates how much more an investor can understand and make predictions about a company beyond metrics like net income and other ones that don't showcase the workings and interconnectedness of a company.

Thanks for sharing!

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