I am new to investing.In Matt Richey's article "Two with hidden value" he says,> Years to Payback: The EV/FCF ratio tells you how many years it will > take to get payback on your investment (assuming no growth or decline > in free cash flow).>It seems to me that "your investment" is not EV, because that is not the price you will actually pay for the shares, so that "years to payback" is more accurately reflected by the P/E ratio.I am missing something?
I think I can help here.When you buy a share of a company you are buying a share in the ownership of a company's future cash flows. The earnings of a company doesn't necessarily represent cash coming into the company. Earnings are calculated by subtracting Expenses from Revenues, and do not include cash being spent on capital expenditures, like buying stores and equipment, or changes in net working capital. Free Cash Flow's does take this into account. Now here is the tricking part. Your investment purchased a claim to these future cash flows of the company, but you are entitled to this claim AFTER the debt holders get there share. They have the first claim and you have the last claim. Enterprise Value takes this into consideration (Market Cap, your money, + Debt, their money, - Cash). So while a company can have positive earnings, it can actually be spending more cash than it is generating in order to achieve these earnings (creating negative cash flows). Without cash the debt will never be paid off, without cash you can never receive a dividend. The debt is eventually paid off with CASH NOT EARNINGS, and your future dividends will be paid in CASH NOT EARNINGS. As any fool would say “CASH IS KING”. Earnings tell only part of the story. I hope I was able to explain this well.
I have a few questions related to Enterprise value as well.I am calculating the Enterprise Value using the Financials and the snapshots here on TMF. The article I read says that:Enterprise Value = Market Cap + Long-term Debt - Cash and InvestmentsMarket Cap and Cash are easy as they are right there in one number. However, what do I include as Long-term debt. I see a balance sheet entry for the Long-term debt in the long-term liabilities section and a Current Long-term debt in the current liabilities sections. Do I add both of these? Are there any other debts that are less obvious that need to be added?Also, other than Marketable Securities, are there any other investments that need to be subtracted.Thanks in advance for helping a confused Fool
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