A company like Amazon is an interesting example of FCF vs. profitability. For years, net income hovered around zero, yet the stock was price quite consistently on a multiple of 20-30x Cash from Operations (and still is today). And FCF was not necessarily great over that period either, as capex spending on warehouses and data centres remained high. So it seems like investors assumed that as long as CFO kept growing strongly, the capex would get good returns in the long run and were willing to invest even if net income and FCF weren't delivering yet today. I'd be curious to know your take on this one. Thanks!
My take on Amazon is that it's on of the few companies that are an exception when it comes to valuation (also the reason why I never bought them). In very rare cases it's revenue that matters above all, especially for such a long time as it's he case with amazon. So market share and revenue growth have been mainly the valuation metric for this company. If you compare it with ebay for examples they clearly lose from a regular valuation standpoint since ebay generates much more cash, has no warehouses and is basically a payment processor that just takes it's cut. But nobody loves ebay, so the market sometimes makes his own rules.
Interesting comparison with ebay. For Amazon, is it not all about CFO rather than revenue? Basically they have huge and growing cash flows before the capex, which is way better than just having huge revenues (which can be the case with a boring supermarket retailer having super low gross margins, for example). So my take is that Amazon has this great CFO, is choosing to spend most of it on CAPEX to grow future CFO, but could "flip the switch" to spend less CAPEX at any time. Hence, investors can get some of those cash flows once amazon decides to stop growing as much. The only problem wit this argument is the part about "maintenance CAPEX" vs "growth CAPEX", that Amazon's network of warehouses and data centres is so big that the maintenance CAPEX part itself must be very large and can't be switched off easily. And that's where net income can be more useful, since that includes the depreciation on the assets (but net income is also reduced by the stock based compensation).
Great summary of the CF statement. I agree that large one off capital expenditures can be a flag, but I think it's not always bad and sometimes it requires a deeper dive to understand what the investment is in and whether it's likely to generate good future return (based on both past performance and understanding the details). If a company has consistently good cash return on investment and the new project makes good business sense then the higher capex might be a good thing? And it's the same with acquisitions too I guess; whilst these don't impact the FCF it can equally destroy the cash left over for shareholders if done badly. (big spikes in acquisitions should be another flag when looking at a cash flow statement, under the investing section)
Yes, correct. If there's a spike in Capex, investors should check what's behind it. If the company is building a new factory to increase production, then of course it's not a red flag but could be a great entry point before the results show up in the following years.
I once saw a definition of a metric called "maintenance capex" vs. "growth capex", where maintenance capex is basically the depreciation (I saw this on unclestock.com). Quite a simplistic definition, but it also helps to split out how much cash needs to be spent just on maintaining/replacing existing assets (e.g. machinery coming to end of useful life) vs. genuinely new investment projects. To me, these can be thought of in a very different way from an investor standpoint. E.g. if a business has a big maintenance capex burden, then the FCF [before major growth investments] would be poor and that is a genuine concern. But if the underlying FCF [before major growth investments] is good, but the company makes big growth capex investment, then I would look at it differently. Have you every heard of a better way to identify maintenance vs. growth capex?
Some companies make it easy to distinguish between growth and maintenance capex (Mcdonalds or Starbucks if I remember it correctly, because they tell you how many new stores they plan to open), but most companies do not, so it's a bit tricky. I think Bruce Greenwald wrote about it in his book on how to calculate it, but I need to look it up myself since I'm not sure if it was him. Thanks for the unclestock website, didn't know about it, looks very useful!
Thanks. Unclestock is very good - it's a home built project by a guy called Peter Nees from Belgium and it offers a lot of global data for a very reasonable price. It has a very large set of metrics/ratios available and some basic charting functionality. It is also a very powerful screener and has some backtesting (but only available on the premium plans). I have the basic "bronze" plan. I also like some of his metrics such as CROIC (cash return on invested capital) which is a bit more useful than standard ROIC in my opinion.
A company like Amazon is an interesting example of FCF vs. profitability. For years, net income hovered around zero, yet the stock was price quite consistently on a multiple of 20-30x Cash from Operations (and still is today). And FCF was not necessarily great over that period either, as capex spending on warehouses and data centres remained high. So it seems like investors assumed that as long as CFO kept growing strongly, the capex would get good returns in the long run and were willing to invest even if net income and FCF weren't delivering yet today. I'd be curious to know your take on this one. Thanks!
My take on Amazon is that it's on of the few companies that are an exception when it comes to valuation (also the reason why I never bought them). In very rare cases it's revenue that matters above all, especially for such a long time as it's he case with amazon. So market share and revenue growth have been mainly the valuation metric for this company. If you compare it with ebay for examples they clearly lose from a regular valuation standpoint since ebay generates much more cash, has no warehouses and is basically a payment processor that just takes it's cut. But nobody loves ebay, so the market sometimes makes his own rules.
Interesting comparison with ebay. For Amazon, is it not all about CFO rather than revenue? Basically they have huge and growing cash flows before the capex, which is way better than just having huge revenues (which can be the case with a boring supermarket retailer having super low gross margins, for example). So my take is that Amazon has this great CFO, is choosing to spend most of it on CAPEX to grow future CFO, but could "flip the switch" to spend less CAPEX at any time. Hence, investors can get some of those cash flows once amazon decides to stop growing as much. The only problem wit this argument is the part about "maintenance CAPEX" vs "growth CAPEX", that Amazon's network of warehouses and data centres is so big that the maintenance CAPEX part itself must be very large and can't be switched off easily. And that's where net income can be more useful, since that includes the depreciation on the assets (but net income is also reduced by the stock based compensation).
I agree. Thanks for the input.
Great summary of the CF statement. I agree that large one off capital expenditures can be a flag, but I think it's not always bad and sometimes it requires a deeper dive to understand what the investment is in and whether it's likely to generate good future return (based on both past performance and understanding the details). If a company has consistently good cash return on investment and the new project makes good business sense then the higher capex might be a good thing? And it's the same with acquisitions too I guess; whilst these don't impact the FCF it can equally destroy the cash left over for shareholders if done badly. (big spikes in acquisitions should be another flag when looking at a cash flow statement, under the investing section)
Yes, correct. If there's a spike in Capex, investors should check what's behind it. If the company is building a new factory to increase production, then of course it's not a red flag but could be a great entry point before the results show up in the following years.
I once saw a definition of a metric called "maintenance capex" vs. "growth capex", where maintenance capex is basically the depreciation (I saw this on unclestock.com). Quite a simplistic definition, but it also helps to split out how much cash needs to be spent just on maintaining/replacing existing assets (e.g. machinery coming to end of useful life) vs. genuinely new investment projects. To me, these can be thought of in a very different way from an investor standpoint. E.g. if a business has a big maintenance capex burden, then the FCF [before major growth investments] would be poor and that is a genuine concern. But if the underlying FCF [before major growth investments] is good, but the company makes big growth capex investment, then I would look at it differently. Have you every heard of a better way to identify maintenance vs. growth capex?
Some companies make it easy to distinguish between growth and maintenance capex (Mcdonalds or Starbucks if I remember it correctly, because they tell you how many new stores they plan to open), but most companies do not, so it's a bit tricky. I think Bruce Greenwald wrote about it in his book on how to calculate it, but I need to look it up myself since I'm not sure if it was him. Thanks for the unclestock website, didn't know about it, looks very useful!
Thanks. Unclestock is very good - it's a home built project by a guy called Peter Nees from Belgium and it offers a lot of global data for a very reasonable price. It has a very large set of metrics/ratios available and some basic charting functionality. It is also a very powerful screener and has some backtesting (but only available on the premium plans). I have the basic "bronze" plan. I also like some of his metrics such as CROIC (cash return on invested capital) which is a bit more useful than standard ROIC in my opinion.
Thank you very much for these articles which I read as soon as those appear to inbox!
I'm happy to hear that!
Thank you very much for explaining in a very simple way with examples.
You're welcome!