This figure is calculated by subtracting capital spending from cash flow from operations for the same time period. Free cash flow is expressed in the millions of dollars ($M). Free cash flow is the money left over after investment, and it can be used to pay dividends, buy back stock, or pay down debt.
Origin
This information is found in the company’s cash flow statement. This information is updated weekly.
Benefit
Free cash flow shows whether a company is really making money or not. It’s the cash flow left over after investment, and can be used by the company to purchase other firms, pay dividends, reduce debt, or buy back stock. Young, aggressive companies typically have negative free cash flow, since they’re investing heavily in their futures. As companies mature, though, they should start to generate free cash flow. Generating heaps of free cash flow is one sign of a highly successful company.
Example
Philip Morris is often lauded for its high free cash flows. Operating in the mature cigarette business, the company generated $6.5 billion in free cash flow in 1997.
For the Pros
To value a company using free cash flow, create a price/free cash flow figure.
Market cap/free cash flow year 1
Just as a P/E ratio shows how many dollars you have to pay to buy $1 worth of earnings, the price/free cash flow ratio shows many dollars you pay for $1 worth of free cash flow. Since free cash flow is unaffected by accounting distortions, and because it’s net of investment, many investors consider this ratio one of the best—and most conservative—ways to value a company.