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Why do you exclude "growth capex" from your FCF calculation?...

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


I think we are on the same page, but my wording may have indicated otherwise. I agree with you wholeheartedly reagarding growth capex - that you can't have your cake and eat it too. We've been having this argument on the HG BWLD board, where a DCF valuation was posted using the following formula:

Earnings + Depreciation & Amort - Total Capex + Growth Capex - Working Capital = SFCF. The SFCF is then discounted back to present.

I argued against adding growth capex back in because that money is spent and cannot be returned to shareholders. I do, however, feel that total capex should be adjusted during the terminal growth years to reflect reduced growth capex spending (in those years only). That's the point I was trying to make, but perhaps not as clearly as I should have.

My thought is that the reason we have such a low terminal growth rate is that the company has stopped reinvesting in growth (or reduced it significantly). I believe an adjustment reflecting that is justifiable. If we expect the tepid terminal growth despite continued high growth capex, we are assuming a poor use of capital in the distant future.

So I propose the following:

During growth phase:
Earnings + (Depreciation & Amort) - Total Capex - Working Capital = SFCF.

During terminal phase:
Earnings + Depreciation & Amort - Reduced Total Capex - Working Capital = SFCF, where capex is reduced to reflect lower growth capex spending.

I've seen this discussion often and I think it arises from TomG's Thumbnail valuation, where he adjusts for growth capex. But that's a future multiple valuation, not a DCF valuation. I think the concept has been hijacked, somewhat incorrectly.

As for my business-owning experience, you are painfully correct - and it underscores the point I was trying to make on the BWLD board. My personal cash flow (what ended up in my pocket) was virtually nil during our growth phase. My wife was getting impatient, wanting to know when we'd see a pay off. So I showed her what was being spent on growth and what would happen when we stopped reinvesting. It was a way to see the light at the end of the tunnel. The investment would pay off, but we couldn't buy groceries with it today. And if I'd told someone they could have all the cash I generated in the next twenty years for an up front payment today, I doubt anyone would have paid me for that future lump sum PLUS the money I invested to earn it. Their only interest would be in the cash they would receive. That's how I look at this whole issue.

Does that make sense? Please correct me if you think I'm wrong, or if you feel I don't understand your thoughts on the subject.



(For anyone interested, the BWLD discussions begin here and here – HG subscription/access required)
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