What is Free Cash Flow (FCF) and Why It’s the Most Important Metric

Core Insights - The article emphasizes the importance of free cash flow (FCF) as a critical metric for assessing a company's financial health, beyond traditional metrics like revenue and net profit [1][5]. Definition and Importance of FCF - Free cash flow is defined as the cash generated by a company after covering its operating expenses and capital expenditures, calculated using the formula: FCF = Operating Cash Flow – Capital Expenditure [3]. - FCF is a more reliable indicator of a company's financial health compared to earnings, as it reflects actual cash available for dividends, share buybacks, debt repayment, and business expansion [4][5]. Implications of Strong FCF - A high FCF indicates financial stability, the ability to sustain dividends, and flexibility to adapt to market changes, as seen in companies like Apple and Microsoft [6][7]. - Strong FCF is often associated with a company's capability to continuously generate profits for shareholders [7]. Implications of Weak or Negative FCF - Low or negative FCF can signal potential issues, such as excessive reinvestment needs or rising capital expenditures that may lead to debt problems [8]. - High-growth companies like Amazon and Tesla may report lower or negative FCF temporarily due to prioritizing expansion, necessitating investor discernment between strategic reinvestment and structural weaknesses [9]. Utilizing FCF in Stock Analysis - Investors should examine FCF trends over several years and consider the FCF margin to assess how effectively a business converts sales into cash [10]. - Focusing on the price-to-FCF ratio rather than earnings provides a more reliable measure of a company's market value relative to its available capital, making it a valuable tool for value investors [10]. Conclusion - Understanding FCF helps investors avoid pitfalls such as yield traps and overleveraged companies, emphasizing the importance of cash flow as a clear measure of a company's strength [11].