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Subject:  Re: Discounted Cash Flow Model - Negative FCF Date:  1/31/2011  1:57 PM
Author:  jackcrow Number:  1628 of 1675


Das Moose has some good ideas suggestions.

The burning questions for companies in the red is cash burn and cash generation. The bottom of the statement of cash flows is an important number to track but it has to be in context to the whole statement.

In a mature company the Financing Activities section is often given little more than a glance unless we are trying to figure out payout ratios or how much they are spending on stock buybacks. In a company that is trying to grow its way to profitability that little chunk of the statement may be the make or brake of the company.

One way to play with this is Cash from Ops - CapEx +or- net borrowings.

This is the money they are generating with the machine. It is a number more closely related to enterprise value then market cap. It also the number I would use to generate some return on metrics like ROC. This may sound odd to put debt into the top of the equation but in the high growth phase of a company access to capital is important. It is their estimated future returns plus their current cash generation that lenders are investing in and their ability to convince investors to invest is a type of return needed for young companies.

So I would track both traditional ROC = EBIT*(1-tax rate)/(BV debt + BV of equity)
Cash from ops - CapEx +or- net borrowings / (BV debt + BV equity)

One other metric to track is the change in interest coverage ratio; where ICR = EBIT/Interest Expense (from statement of earnings). The raw number for these early stage companies is often ugly so tracking the change qtr/qtr and yr/yr becomes valuable. A pattern should be discernible if the pattern is acceptable then deviation from that pattern is either a warning or the signal for an opportunity.

Ultimately what we are trying to figure out is when the cash burn starts to slow because of the returns being generated. Valuing a company who's yr1 earnings = -100, yr2 earnings = -200, yr3 = 250 is really difficult. When they get to the point where we have the opposite pattern and we can see the Statement of Cash flows improving along the same trend lines then we can estimate in what year they will be cash flow 0 and the next year when they are cash flow positive.

Make sense

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