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Free Cash Flow


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Table of Contents

Foreword xv Preface xix CHAPTER 1 Investing 101 1 Price 1 Free Cash Flow 2 Risk and Return 3 The Return Multiple 4 Return and Price 4 Debt 6 Equity 9 Debt versus Equity 11 Private Company versus Public Company 12 CHAPTER 2 The Accounting Fog Machine 15 GAAP: Competing Theories, Matters of Opinion,Political Compromises 16 GAAP: Accrual Abuse 17 GAAP: Errors Bred by Complexity 17 GAAP'S Gap 18 GAAP EPS: An Incomplete Definition of Financial Performance 18 GAAP EPS: Investing in an Economic Vacuum 18 EBITDA is Not a Cash Flow Metric 19 The GAAP Cash Flow Statement 19 Beware the Balance Sheet 20 Liquidity 21 Fixed Assets and Depreciation 21 Leverage and Debt Service 22 Whose Return on Equity? 22 The Notes 23 When Do Accruals Meet Cash Flows? 23 What is to be Done? 24 CHAPTER 3 Free Cash Flow 25 Reconciliation of Net Income and Free Cash Flow 25 Free Cash Flow versus Net Income 27 A Universal Definition? 28 Academic Research and the Discounted Cash Flow Model 29 Barron's Rankings 30 Buy-Side Users 31 Private Equity Firms 31 Warren Who? 31 A Vast Media Conspiracy? 32 FASB Staff Findings 32 FAS 95: A Cruel Rule 33 EPS Misses: The Real Deal 33 An Alternative to the Government Number 34 CHAPTER 4 The Free Cash Flow Statement 35 Building the Free Cash Flow Statement 35 Four Key Questions 40 Revenues 41 Operating Cash Flow 43 Working Capital 44 Capex 45 Capex: Magnitude and Risk 46 Capex and Capital 47 Capex Transfer 48 Capex Visibility 48 Capex and Investor Return 49 Free Cash Flow 49 Free Cash Flow Yield 50 CHAPTER 5 Free Cash Flow Deployment 53 Acquisitions 54 Buybacks 56 Dividends 59 Debt 60 Projecting Investor Return 61 CHAPTER 6 The Free Cash Flow Worksheet 65 Worksheet Features 66 Entering Historical Data 68 Adjustments to GAAP Cash Flow 68 Operating Cash Flow 71 Capex 71 From the Balance Sheet 72 The Free Cash Flow Statement 73 GAAP Data 74 Percentages 75 Per Share Data 76 Incremental Data and Company's Reinvestment Return 77 Cash Sources and Deployments 78 Acquisitions 80 Buybacks 80 Dividends 81 Debt 82 Operations 82 Projecting Free Cash Flow 83 Projecting Cash Sources 86 Projecting Acquisitions 87 Projecting in Share Value Due to in the Number of Shares 88 Projecting Investor Return from Dividends 90 Projecting in Share Value Due To in Debt 91 Projecting in Share Value from Operations 94 GAAP Data, Percentages, and Per Share Data 94 Incremental Data and Company's Reinvestment Return 95 Investor Return Projection 96 Return Multiple 98 Adding Periods to the Worksheet 100 Using the Worksheet 100 CHAPTER 7 Six Companies 101 Revenues 102 Percentage Change in Revenues 102 Operating Cash Flow Margin 103 Capex as a Percentage of Revenues 105 Free Cash Flow Margin 106 Free Cash Flow Per Share 107 The Government Number 109 Net Nonworking Capital Items 109 McDonald's 111 Panera Bread 113 Applebee's 114 P. F. Chang's Bistro 115 Cheesecake Factory 116 IHOP 118 Three Musketeers without New Unit Capex 121 Whose Return on Equity? 121 Sell-Side Analysts 124 Total Returns 125 Take Your Pick 125 CHAPTER 8 The CEO and Investor Return 129 The CEO's Letter to Shareholders 129 The Quarterly Earnings Conference Call 135 The CEO's Incentive Compensation 137 CHAPTER 9 Finding Great Stocks 145 The Nine Steps 145 Diversification for Individual Investors 150 Equity Mutual Funds 151 Free Cash Flow and Bonds 152 Free Cash Flow and the Financial Crisis of 2008 152 APPENDIX A Equations 153 APPENDIX B McDonald's Income Statement 159 APPENDIX C McDonald's Balance Sheet 162 APPENDIX D McDonald's ROIIC and Weighting 164 APPENDIX E McDonald's ROIIC Calculations 165 APPENDIX F Recommended Reading 168 Notes 171 Acknowledgments 174 About the Author 175 About the Website 176 Index 177

About the Author

GEORGE C. CHRISTY, CFA, has more than thirty years' experience in the financial markets. He has served as corporate banker for Fortune 500 and middle market companies, as well as treasurer of a publicly owned telecommunications equipment manufacturer. Christy has a BA from Princeton University and an MBA from the University of Chicago, and holds the Chartered Financial Analyst (CFA) designation. He is a member of the Los Angeles Chapter of Financial Executives International, the CFA Institute, the CFA Society of Los Angeles, the Japan America Society, and the International House of Japan.

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