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Subject:  Re: What's Your Portfolio's PIV-ER? Date:  2/3/2007  3:19 AM
Author:  TMFAdmiral Number:  1283 of 1817

Hi Paul,

Why do you exclude "growth capex" from your FCF calculation? It and any increase in working capital is the fuel for growth and once spent can not be distributed to shareholders. Imo not counting growth capex in FCF falls in the same category as not counting stock options as an expense - it's pure fiction.

Let's say we have two companies in the same industry with a $100m in revenues and produce $10m in FCF. Both require $10m in "maintenance" capex to maintain sales and profitability. Company A is happy to stay at this level but company B wants to grow aggressively and starts ramping up capex to $20m per year. Using your maintenance capex only both companies would only count $10m in FCF. Naturally analysts now project growth for company B, let's say 20% for the next five years vs. little more than inflation, say 5% for company A.

In this example company B gets its growth for free - no inputs needed because growth capex is not included. I see from your profile that you list "business owning" & I'm sure that your own experience of investing "growth cash" would point to its inclusion in capex for the calculation of free cash flow to you the owner

It's easy enough to model zero or negative cash flows for the first few years for high growth companies using a DCF spreadsheet so I'm not sure why its important to exclude growth capex.

I think it's important to understand what maintenance capex is and I've sometimes played around with the DCF for a higher growth company by using maintenance capex only and assuming very modest growth rates - a sort of "what would cash flows look like if the company stopped its rapid expansion" idea.

imo you simply can't have the higher assumed growth rates and at the same time exclude the capital necessary to achieve them

Best Regards
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