How To Understand Free Cash Flow and Why FCF Is So Important | Exploring Markets

How To Understand Free Cash Flow and Why FCF Is So Important

Free cash flow is one of the most underrated metrics in the stock market.

Some people call free cash flow FCF for short.

So what is free cash flow? In this post you are going to learn the basics and understand why it's so important when looking at companies and their stock price.

Free cash flow is the cash a company has BEFORE it decides to do things like invest in new products, grow its research and development team, acquire other companies, pay dividends to shareholders, buyback stock, or reduce debt.

Read the sentence above again.

Free cash flow is essentially the money a company has that can be used for growth and shareholder rewards. If you think about it, no single metric is more important than this. Without consistent or growing free cash flows, a company will be unable to do things that support its long-term plans or make its investors happy. Far too many people fixate on earnings per share (EPS) or even revenue and NOT free cash flow.

The exact formula for free cash flow is this:

Cash Flow from Operations - Capital Expenditures = Free Cash Flow

Basically, the formula above shows what free cash flow is. Take the cash you earn from running a company and subtract the fixed costs associated with it. That means things like property, land, equipment, and employees. The money leftover is your free cash flow. That's the money that now goes into growth strategies, new hires, dividends, buybacks, or anything else.

If you're a new investor, or someone trying to learn more about the stock market, keep this short memo in mind the next time you analyze a company and stock. As mentioned earlier, this is a severely underrated and underreported metric. Rarely will the media ever talk about this and websites like Google Finance and Yahoo Finance do not display it anywhere on their main pages. Looking at free cash flow will change the way you analyze stocks and find value.

*If you found this helpful, you now need to go read why PE Ratio is misunderstood and what not enough people know*