I've laid off posting for a while, but as I look back over my recent posts I realize that I've lost a bit of why I started this blog in the first place. Ideally, I was hoping to share some more of the how behind finding investment ideas. To bring out that old cliche, I wanted to teach readers to fish rather than just handing out fish (and lately I've been sparse with the fish too).
While I will probably still give some general news analysis, I know you can get that a lot of other places -- one of which is The Motley Fool (www.fool.com) where I write full time. So I'm not too concerned that you'll be missing out on extra news coverage.
Anyway, to kick things off, I briefly covered discounted cash flow valuations in the past and got a question on where you can get cash flow projections. My plan was to cover that here and, well, I never did!
To start with we need to define what free cash flow is since there are a bunch of different ways that people go about calculating it. For what I'll be doing here, free cash flow will be defined as:
EBIT * (1 - tax rate) + depreciation & amortization - net additions to working capital - capital expenditures
So before we move on to making projections, let's make sure that we have this down. First you need to find EBIT (earnings before interest and taxes, also known as operating profit). As an example, we can look at the income statement for Coca-Cola (NYSE: KO). EBIT (operating income) appears right under the operating expenses ($6.3 billion in 2006). That's where we start.
Next we need to figure out the tax rate. To do this, just run down the income statement to the income tax line ($1.5 billion) when you take this as a percentage of income before tax ($6.6 billion) you've got your tax rate -- in this case 23%.
To find the rest of what we'll need, we need to flip over to the cash flow statement. Finding depreciation and amortization (just listed as depreciation here) and capital expenditures is easy -- just run down the statement (they're $938 million and $1.4 billion, respectively). Working capital is a bit trickier, but not much. To get this just tally everything under operating activities except depreciation. You should come up with -$61 million.
Now you just put it all together:
$6.3b * (1-.23) + $938m - $61m - $1.4b = $4.3b
Two things that I should point out are working capital and capital expenditures. Items appear on the cash flow statement according to how much cash they add or subtract from the company's coffers, so you have to make sure you don't try to subtract negative capex or working capital additions. If it makes it easier you can say that you are just adding all the numbers you pull from the cash flow statement.
That's probably a good start, in my next post I'll tackle actually starting to make future projections.
-AvgJoe
October 5, 2007
Did you like this article?
's
