Reviewed and Updated On: 10 Jul 2024
Ever looked at a company's earnings and thought, "Wow, this looks great!" only to find out later that they're struggling to stay afloat? That's where Free Cash Flow Per Share (FCFPS) comes in.
Earnings Per Share (EPS) can be a good starting point and is an important profitability metric, but as investors, we should never overlook FCFPS.
FCFPS is another profitability metric that divides a company's free cash flow by the number of common shares outstanding.
Free Cash Flow Per Share = (Operating Cash Flow - Capital Expenditures) / (Shares Outstanding)
In other words, this measures a company's ability to pay debts, pay dividends, buy back stocks, and facilitate business growth.
Many investors consider FCFPS to be a better measure of a company's financial flexibility, which is its ability to react to unexpected expenses and investment opportunities.
So why should you not ignore Free Cash Flow Per Share?
This is because a company’s FCFPS is a more reliable value than a company's EPS, which can be manipulated through accounting practices. Cash flows present the true picture, but earnings can be manipulated.
Net income is calculated after the company generates revenues. However, sales or services provided are often made on credit. For example, the company can record a sale made but only collect cash six months later. This increases earnings but results in no cash inflow. It is also calculated after deducting the cost of depreciation and amortisation (non-cash expenses).
All these factors can inflate or deflate the value of net income artificially.
On the other hand, cash flows are influenced by the company's cash from operations, which gives investors an insight into the core of a company's cash-generating machine. Henceforth, higher revenue, lower overhead, and more efficiency drive cash flow from operating activities.
Cash can also help companies expand, develop new products, buy back stocks, pay dividends, or reduce debts.
Knowing this, one notable application of the Free Cash Flow Per Share is that it can be used to confirm a company’s EPS growth year-on-year due to greater profitability and cash flows rather than accounting tricks.
For example, you can see below that as S&P Global Inc.’s Earnings Per Share rise, the company’s Free Cash Flow Per Share also increases. We can affirm that the company’s EPS growth is due to greater profitability and cash flows rather than accounting tricks.
For creditors, a low FCFPS means weak solvency, and providing loans for the company is risky.
Lastly, investors can use FCFPS to give a preliminary prediction regarding its future share prices.
When a company’s share price is low but FCFPS is increasing, the share price has a higher chance of rising. This is because high FCFPS will mean that the EPS should potentially be high as well, typically followed by an increase in share price.
The next time you look at a company, don't be fooled by EPS alone. Dig deeper and check the FCFPS. It's the key to unlocking a company's financial health and making smarter investment decisions. Remember, cash is king, and FCFPS is the crown!
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