Free cashflow is a big part of the way we analyze stocks here. The more cash, the better. But just generating cash is not enough (although it is essential). We need to know what the company has done with its cash. Sure, some will go to pay taxes, and, if the company is capitalized with debt, some will go to make interest payments. But what about the rest? Was it used to pay down debt? As conservative investors, we see this as a positive action, although modern finance theory might debate that. Was it used for dividends? That's always good, we like to see cash returned to the owners. Was it used for share repurchases? That can be good if the shares were repurchased at reasonable valuations. But was the cash just used blindly to buy back shares, regardless of price? Were there acquisitions made? If so, how did those acquisitions turn out? Did revenues and profits increase as a result of the acquisition? If not, it could mean the acquisition hasn't had time to bear fruit, or it was simply a bad one, or it could mean the original business is on the decline and acquistions are required just to keep the business from shrinking. Is the cash building up on the balance sheet? If so, why? Is the company planning an acquisiton? Often with smaller companies, a significant build up of cash can be the precursor to the start of a regular (or special) dividend payment.
These are some of the questions we ask as part of our analysis, and if we don't like the answers, we'll think twice before investing our money and/or demand a larger margin of safety.
Tuesday, December 8, 2009
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