Cash flow is the net amount of cash that gets transferred into and out of a company. At the most basic level, a company's ability to create value for shareholders is determined by its ability to generate positive cash flows. A company with positive cash flow can add to its cash reserves, reinvest in the business, pay out dividends to shareholders, or settle future debts.
There are three forms of cash-flow: operating, investing, and financing. Operating cash flow includes all the cash generated by the main business activities. Investing cash flow consists of all acquisitions of assets, plus investments in other ventures. Financing cash flow includes all funds incurred by issuing or paying off debt, but also issuing or repurchasing equity.
How can I use information about cash flow when I invest in stocks?
- You can use a company's cash flow to determine the financial health of the company. Suppose the cash inflow is more than the cash outflow. In that case, it means that the company has a positive cash flow, indicating that its liquid assets are increasing and can pay for its salaries, creditors, as well as reinvest the remaining amount to grow the business. Companies with a positive cash flow are also able to provide a buffer against future financial challenges, which helps them to stay resilient during market downturns. For example, Walt Disney was severely affected by the COVID pandemic as it reported a -$1,100 million loss in its trailing twelve months earnings. Still, its positive free cash flow cushioned the negative impact.
- You can also use a company's cash flow to determine a company's stock valuation. You can first determine the company's free cash flow by subtracting all its capital expenditure from net cash from operating activities. That value represents the cash flow available for the company to repay its creditors or pay dividends to its investors. The higher the amount of free cash flow, the higher amount of dividend you can stand to receive. The discounted cash flow model of stock valuation is also another way of valuing stocks and is based on the assumption that current stock price is the present value of all future free cash flows that company will have. Thus, companies with higher cash flow such as tech stocks like Apple (with a trailing twelve months free cash flow of $71,706 million) can reinvest these cash flows into further growth.
Debt to Equity Ratio
Used to evaluate a company's financial leverage and is calculated by dividing a company's total liabilities by its shareholder equity.
Profit is the financial benefit realized when revenue from a business is higher than the costs and taxes involved in operating that business.
Alternative investment class composed of funds that invest directly in private companies or that buy public companies and take them private
Time of declining economic activity, lasting more than a few months, normally visible in real GDP, real income, employment, industrial production, and sales.
A stimulus package is a coordinated effort by the government to increase spending and investment to "stimulate" an economy out of a downturn.
Shorting a stock
Trading strategy that tries to take advantage of the decline in a stock price by borrowing a stock and sell it now while planning to repurchase it later for a lower price.
Market-capitalization-weighted index tracking the performance of the 500 largest U.S. companies