Spotting Good Business Via Free Cash Flow

In good or bad times, there are always good business surviving and thriving. Investors want to put their money into good business to earn returns. But it’s not that easy to spot the good business.

Employing a statistical and broad-category based mindset, I turn to data and metric for an answer. Recently, I was impressed by an audio clip preaching “Free Cash Flow” rather than “Profit” or “Earnings” as ultimate measuring yardstick. It makes sense when the author uses example of capital heavy companies like aircraft manufacturing as example. For those companies to make extra earnings, they can’t realize unless continue injecting more capital. From the perspective of earnings, their accounting book may look sound, while via the lens of free cash flow, which is the number subtracting initial input capital from earnings, the output is sure unpleasant.

Both Warren Buffet and Jeff Bezos hold firmly that FCF is the key.

So I dive into 2538 US companies (with a filter of market cap >= $250m 3month ADTV >= $0.75m), breaking them into sectors to learn who are providing better performance in terms of FCF. The distribution of their FCF looks like

So what companies/sectors sit on both polar ends? statistically, setting +0.5 and -0.5 as threshold, the number of companies at extreme ends only make up for about ~2.5%.

High FCF
Low FCF

Even it makes a lot of sense to see Aerospace and Defense Manufacturing categorized into low FCF group, Insurance in high FCF group, it’s odd to see Specialty Fiance and REITS shown up on both buckets. The explanation has to be idiosyncrasy.

Listed below some commonly looked up companies:

Berkshire Hathaway, Inc.’s FCF is 0.049, Apple 0.044, Amazon 0.018, Facebook 0.041, FactSet 0.034, Goldman Sachs 1.25, Tesla 0.0075, and JPMorgan -0.005… (as of April 17th 2020).

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