CHRIS BATCHELOR | from Stockopedia

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Free Cash Flow hard to fake it unless you make it - Chris Batchelor from Stockopedia
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I think we can become easily confused by the jargon, metrics and ratios that analysts use to value companies. That's why I like to break them down one by one. I'm joined in this episode by Chris Batchelor from Stockopedia to discuss Free Cash Flow - what does it mean and why is it important?


If you're a cafe, you've got revenues, obviously when patrons pay for their food, et cetera, expenses are paying your staff, paying the rent for the premises, paying for the food to provide the people. So when you take those two numbers, revenue less expenses, you get operating cash flow. Now to get from there to free cash flow, the restaurant might decide that, okay, we, we want o redecorate, so we need to set aside a hundred thousand dollars to redecorate the restaurant that gets deducted from your operating cash flow to arrive at your free cash flow.

And so typically there's three things that happen with Free Cash Flow. They, if they have debts, they can pay them down. If they have cash in the bank, they might wanna just add to that for, you know, a rainy day or for next year's investments, or they'll pay dividends to the shareholders. In, in the case of a cafe, it's probably, you know, the owner of that cafe.

Free cash flow is the amount of money that a business generates after paying for its operating expenses and investing in its growth. It is the cash that is left over for the owners or shareholders of the business to use as they wish. They can use it to pay off debt, save for future projects, or distribute as dividends.

To understand free cash flow, we need to start with operating cash flow. Operating cash flow is the money that a business makes from its core activities, such as selling products or services. For example, if you are a cafe, you have revenues when customers pay for their food and drinks, and expenses when you pay your staff, rent, and suppliers. The difference between your revenues and expenses is your operating cash flow.

However, operating cash flow does not tell the whole story. A business also needs to invest in its growth, such as buying new equipment, expanding to new locations, or developing new products. These investments are called capital expenditures, and they reduce the amount of cash that is available for the owners or shareholders. Therefore, to calculate free cash flow, we need to subtract capital expenditures from operating cash flow.

Free cash flow = Operating cash flow - Capital expenditures

Free cash flow is often seen as a better indicator of a business's health than other metrics, such as net income or earnings per share. This is because free cash flow reflects the actual cash that a business generates, rather than accounting estimates or assumptions. As the saying goes, "profit is opinion, cash is fact".

For a beginner investor, free cash flow can reveal how well a business is managing its operations and investments. A positive free cash flow means that a business is generating more cash than it needs to run and grow, which is a sign of efficiency and profitability. A negative free cash flow means that a business is spending more cash than it earns, which could indicate problems or opportunities.

Of course, free cash flow is not the only factor to consider when evaluating a business. It is also important to look at the quality and sustainability of the cash flows, as well as the growth potential and competitive advantage of the business. Some businesses may have low or negative free cash flows because they are investing heavily in their future growth, which could pay off in the long run. Others may have high or positive free cash flows because they are mature or declining businesses that have limited growth opportunities.


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Chloe (1s):

Shares for Beginners, Phil, Muscatello and Finpods are authorized reps of MoneySherpa. The information in this podcast is generally nature and doesn't take into account your personal situation.

Chris (13s):

Businesses don't fluctuate day to day. Markets might, but businesses generally, the impact on a business are fairly gentle, except when you have these one-off major events. They're the types of things we talked about earlier that just can't be foreseen. But as a general rule, a business is fairly steady and, but the market sentiment can be quite erratic.

Phil (34s):

G'day, And, welcome back to Shares for Beginners. I'm Phil. Muscatello. There's a plethora of numbers and Valuation techniques. When you first start looking at company reports, is there a simple measure that can help you weeded out the losers and focus on companies that have a better chance of performing? Well? Free cashflow is one of those metrics, and it's still one that I still don't fully comprehend. So coming back to the microphone to explain, I'm welcoming back. Chris Batchelor from Stockopedia. G'day. Chris

Chris (1m 4s):

Good day, Phil, great to be with you today.

Phil (1m 7s):

Yeah, thanks for coming back. I like using the word plethora. There's a, there is a plethora of numbers, isn't there? There

Chris (1m 13s):

Is. There's an absolute mountain of material that one could look at when looking at Stocks.

Phil (1m 18s):

Yeah. And plethora. It means a lot. Yeah. Chris has worked in financial markets for almost 30 years, initially with fund managers, and most recently in stock market research. He likes to understand a business trying to place a Valuation on it while being acutely aware of the vagaries of forecasting. So how vague is the business of forecasting?

Chris (1m 39s):

Well, Phil forecasting is actually very difficult and, and particularly when it involves the future, as you said, there's a myriad of unforeseen events that can affect a business, but what we do know is the future does tend to rhyme with history. So we can get a reasonable idea of what it might look like. But it's important too, not to be fooled by what I call the fallacy of precision forecasting. Sometimes you'll see forecasts and they've got, you know, three decimal places that's meaningless. Forecasts are best considered to be a range of likely outcomes. and the further out you're trying to forecast, well the wider that range really needs to be. You've also gotta consider the types of businesses that you're looking at.

Chris (2m 22s):

'cause different businesses have different characteristics when it comes to forecasting. So take for example, if you were looking at Woolworths or comparing that to Grain Corp, the revenue for a business like Woolworths is fairly predictable. You know, that people are gonna continue going to the supermarkets and they're probably gonna buy roughly this similar amount to what they bought last year. But a business like Grain Corp, there's so many variables that can affect their future revenue. Everything from the price of wheat, which is impacted by droughts, by floods, by wars in foreign countries. So there's so many things that could impact that business. And therefore, any forecast that you put together, you have to understand that there's a, a lot of variability in that and a lot of risk attached to that forecast.

Phil (3m 12s):

So there's always a range of outcomes in the future. And there's many analysts like You can read analysis on many of the financial news sites and in, in your brokerage that seem to have, you know, what they call a buy, sell, a hold recommendation based on their own forecasting. How much credence should we place on those?

Chris (3m 34s):

That's a hot question. Are the the answer is

Phil (3m 38s):

The answer it in, answer it in the nicest possible way.

Chris (3m 40s):

Yeah. I try to be diplomatic, but yeah, I, the forecasts are worth looking at because the people that are making those, generally, they've spent a lot of time looking at those businesses and they understand the businesses very well, right? So their, their forecasts are not meaningless and you certainly shouldn't throw them out. But what you do need to bear in mind is that they don't have a better view of the future than anybody else, right? So whilst they understand the business, they don't necessarily understand or have any insights into what may happen in terms of those unforeseen events. And they're really the things that throw out all forecasts, right?

Chris (4m 20s):

So certainly use that as a starting point, but don't be too wedded to it. And again, think about the type of business. If you're looking at Telstra and someone gives you a forecast for their earnings for next year, yeah, it's probably in the right ballpark. But if you're looking at some mining company that hasn't yet established a, a ongoing business, then it's any man's guess as to how that business is going to do over the coming year.

Phil (4m 49s):

And that's particularly relevant for a, when you refer to Grain Corp or with a mining company because it's so much to do with the commodity price behind it as well.

Chris (4m 58s):

That's right. And personally, I don't invest in commodity businesses because there is just so much variability in trying to predict those prices and, and the business itself has no control over that. They're simply a price taker and they have to accept whatever the market is o offering at that point in time.

Phil (5m 16s):

Hmm. Okay. Well, so this episode we're gonna focus on free cash flow, and I still don't quite understand it fully. Can you explain it to me simply so I've got a good idea of what free cash flow is?

Chris (5m 29s):

Yeah, sure. So free cash flow, and I'll start just with the technical definition, but it's operating cash flow minus capital expenditure. So what does that mean? Well, it's the cash leftover after a business is paid all its expenses as well as making necessary investments to ensure its future and its growth. Or put it another way, it's cash left over that can then be used to pay down debt to increase the money that's in the bank account or to pay dividends to shareholders.

Phil (5m 59s):

And whereabouts can an Investor find this, this number?

Chris (6m 4s):

Yeah. Well, I mean, You can calculate it yourself by going through the annual reports of a, of a business and looking at the, particularly the cash flow statement, that's great and it's good to do that, to understand everything, but of course that's not simple. There are other sources where You can get it. I was just looking at my online broker, which is CommSec. They have what's called operating cash flow, but they don't have free cash flow. and the difference between those two things, your operating cash flow is the cash that you generate through the normal operations of your business. So your revenue less, your expenses, free cash flow takes into account investment.

Chris (6m 44s):

So most businesses are going to need to set aside some of their cash to invest in maintaining their systems or indeed upgrading, improving or adding on expansion for the future. So free cash flow takes that into account as well. And that wasn't available in CommSec, it is available in tools like the one I represent Stockopedia, we have a, a nice clear line for it and, and no doubt there's some other tools as well that would cover it.

Phil (7m 13s):

Can we go back to, so like a very simple analogy, let's talk about a simple business, I don't know, say for example, a cafe. So you've got revenue coming through the door, there's, you know, every dollar that comes in, that's basically the gross revenue. And then out of that, what are the numbers that would bring it back to that free cashflow number?

Chris (7m 35s):

Yep, sure. So, you know, if you're a cafe, you've got, you know, revenues, obviously when patrons pay for their food, et cetera, expenses are paying your staff, paying the rent for the premises, paying for the food to provide the people. So when you take those two numbers, revenue less expenses, you get operating cash flow. Now to get from there to free cash flow, the restaurant might decide that, okay, we, we wanna redecorate, so we need to set aside a hundred thousand dollars to redecorate the restaurant that gets deducted from your operating cash flow to arrive at your free cash flow.

Phil (8m 12s):

Okay. So it's basically then like that's the, the amount of money that's left out. Well, the free cash flow then is the amount of left money left over unencumbered, and the owners of the business can do whatever they want with those funds. That's

Chris (8m 26s):

Right. And so typically there's three things that happen. They, if they have debts, they can pay them down. If they have cash in the bank, they might wanna just add to that for, you know, a rainy day or for next year's investments, or they'll pay dividends to the shareholders. In, in the case of a cafe, it's probably, you know, the owner of that cafe.

Phil (8m 42s):

So this is often seen as the kind of number that really gives a good idea about how a business is operating. And I came across a quote recently, profit is opinion, cash is fact. What does this mean for a beginner Investor? And how can free cashflow reveal this truth as opposed to other numbers that we see in all the numbers that presented to us?

Chris (9m 3s):

Yeah, the quote's probably a tad harsh, but it draws from the fact that there is some discretion as to how profit is determined, but it's very difficult, although not impossible, but very difficult to manipulate cash. So accounting standards are used to measure profit and to interpret when we determine certain revenue and expense items. So without getting too technical, it's, it's around this what's called accrual accounting. And what that basically means is that a business tries to match revenue and expense to when the period when it occurs. Very simple for a cash business, you know, the, the revenue occurs when the cash is received, but if you think of an, a business, like there's a house being built next door to me, right?

Chris (9m 50s):

So the revenue will come in when the gentleman pays the contractors in terms of recording that on the books. If that was a listed company, they would record the revenue as the work is being done. Likewise, they would record the expenses at the same time when that work is being done, even though they might not pay their subcontractors until a month or two down the track. Now that's all straightforward, more or less, but there does start to become discretion and particularly around businesses where there's some interpretation required to work out the revenue. Now I'll give you an example. There's a business called Shine Justice.

Chris (10m 30s):

You may have heard of them. They're a law firm and their business is all around helping people that have some sort of compensation claim. They do class actions, and they also do things like if you're in a traffic accident and you wanna make a claim for that, and they work on a, the basis of no win, no fee. So what that means, of course, is that they'll go through the case, they'll do all the legal proceedings, et cetera, and that can take a year, sometimes two before they get an outcome. And they only know if they're gonna get paid for that once they get a judgment And, you know, if they're successful or not. So what they do, they record revenue each year and they record it based on assumptions about the future. And those assumptions are basically, well, we know from history that we win 67% of cases or whatever, I know the number, but it, you know, there's a percentage that they win.

Chris (11m 17s):

And so they say, we estimate that our revenue will be this. And they record that in their books as their revenue. Now what happened a number of years ago is they were doing that for a while and then it became apparent that they'd been overly optimistic in that assumption and they weren't winning as many cases as they expected to. So all of a sudden they had to write down all this revenue that had never actually been realized as cash. They'll often not receive the cash for a year or two down the track. And so then you get this big write down on their books. You contrast that with a business like Coles where the revenue comes in right at the point, the point of the transaction revenue's very visible and easy to understand.

Chris (11m 58s):

Whereas in a company like Shine, they're not necessarily trying to cook the books, it's just that they really do have to make assumptions and sometimes they get those assumptions wrong. So

Phil (12m 8s):

You, you look at so many different numbers, I mean, you're an expert so you know, you love the numbers and you're, you're passionate about looking at all of those numbers. But for someone who's just starting out, why is it important for a beginner to pay attention to this particular metric that we're discussing?

Chris (12m 24s):

Let me answer that by giving you an example. You'll remember the, the GFC some 15 odd years ago. Now I was a, a relatively young man back then and I invested in a stock called Babcock and Brown. Now, at the time, that was a really hot stock. And I'd looked at it and I'd seen that the profits were really growing. And so I put some money into it. It soon started going down as, as you know, the GF started to take hold. And I was reading through the financial statements one day and I was going over the cashflow statement and I noticed that they were producing negative cashflow. In other words, the cash that they were receiving was significantly less than the cash that they were spending.

Chris (13m 6s):

And I looked at that and I came to the conclusion that, gee, it's a complicated business, this investment banking and I probably don't really understand it, so it's probably okay, that's probably just the way these businesses operate. The only thing that was complicated about It was the creative accounting. The fact was they were burning cash and soon they went broke. And I lost my entire investment. Pleased to say I've never made that mistake again. I always keep a very close eye on cash generation. So it's really important just to look at that number and it's there in the financial statements or you know, in various tools that You can access like ours where You can just look at is this company generating positive cash?

Chris (13m 47s):

And if the answer's no, there needs to be a good reason why it's no,

Phil (13m 53s):

I think I made that exact same Babcock and Brown mistakes. You're still getting any correspondence about the class actions till these however many years later?

3 (14m 1s):

Yeah, I haven't seen anything for a while, but yeah,

Phil (14m 4s):

Don't think we're gonna see any dollars from that.

3 (14m 6s):

No, no, that one's gone. That's gone. Just write that off.

Phil (14m 10s):

So why is FCF or free cash flow hard to manipulate?

Chris (14m 16s):

Yeah, well I mean the, the simple answer to that is cash has to be reconciled back to the bank account, right? Auditors can quickly verify whether that cash is legit or not. Whereas profit, you know, as we described, it's subject to some legitimate adjustments, but there are also the possibility of small or even significant manipulation of profit. And it can be very hard for investors to distinguish that sometimes even auditors or quite often auditors get the wool pulled over their eyes as well. So yeah, I, I like, like to watch out for companies that have impairments or write downs. Again, they, they can be legitimate reasons for that, but often what that means is we were overly optimistic a few years ago and so now we're trying to cover our sins and write down those problems.

Chris (15m 4s):

If they're doing that on a regular basis, you really need to ask questions as to how robust is their accounting. Things like revenue can be bought forward, you know, if a company wants to make their profits look a bit more attractive, they could bill for work Earl before it's actually being completed. If they're really dodgy, they can even raise false invoices. Expenses can be deferred when they should be accrued in that period. But you can't do that with cash, right? You've either got it or you haven't. And so that's why, as we say, it's hard to manipulate cash because it's very easy to verify is it there or is it not?

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Phil (15m 58s):

And often in these conversations we talk about EBITDA, which is another way of massaging the figures. What's that Charlie Munger quote about EBITDA? You might remember it.

Chris (16m 8s):

No, sorry,

Phil (16m 9s):

Drawing a blank

Chris (16m 10s):


Phil (16m 11s):

Oh, he just calls it bull Bull dust.

Chris (16m 13s):

Yeah. Well EBITDA is sometimes considered similar to cash for those who aren't sure it's earnings before interest tax depreciation and amortization. Now the reason that's similar to cash is the biggest difference between your cash operating cash and your profit is that depreciation and amortization and those are basically fancy words that mean if you buy an Asset, you write that down over a period of time. So if you're an airline, you buy a plane, you expect it to last 20 years. In simple terms, you would write off 20% of that. It's not 20% 5% of that purchase each year to your profit and loss. But of course in terms of your cash flow, the money went out the day you bought the plane.

Chris (16m 57s):


Phil (16m 58s):

What are you looking at in FCF data for a company that shows that it's a healthy and strong growing business with potential?

Chris (17m 5s):

Yeah. Okay. So first thing to note is that cashflow often does fluctuate from period to period and there's often quite legitimate reasons for this, right? So you don't necessarily wanna get alarmed if you just see that oh, the company generated negative cash this most recent period, if there's a legitimate reason. But you wanna look into it and understand that what I like to do is I like to look at a longer period, say five years. And what I actually do is I'll add up the operating cash flow over the five years and then I'll add up the reported profits over that same five years and I'll compare the two and I'll literally divide operating cash flow by reported profit. And if you get a number that's above 0.8, then you'd say, yeah, that's probably a fairly strong company.

Chris (17m 50s):

you know, one is ideal, but 0.8 you know, allows for some fluctuation but it's not too much fluctuation. So you really do want to see that the numbers that a company is reporting as profit are starting to equate with cash over the longer term. Otherwise you start to question is that profit genuine or not?

Phil (18m 11s):

Can you explain that again, but the 0.8 to one, what is that ratio? The, the product of?

Chris (18m 17s):

Yep. So what I'm doing there is adding up the operating cash flow and then adding up the reporting profit and then I divide cash flow by profit. So what that's telling me is how close is the cash flow to the profit.

Phil (18m 32s):

Oh, okay. Right, right. So you want, you want those figures to be pretty close to each other.

Chris (18m 36s):

That's right. Yeah. As I said, not necessarily year to year, but when you're looking at over a period of time, you know, a longer period, four or five years, that should be pretty close.

Phil (18m 45s):

You referred to the G F C A moment ago, and I just want to look at volatility for a moment because obviously the prices of companies in the markets are volatile, they go up and down and especially appearance like the G F C or the, the Covid crash, they can fall quite significantly, but cashflow is not as volatile. Is that the case?

Chris (19m 7s):

It depends on the company. It is the, the case for businesses that have stable cashflow like a retailer or a supermarket as any sort of consumer staple type business. But cashflow can be volatile because sometimes companies particularly free cash flow 'cause companies will make investments, right? So looking at an airline, they decide to buy a whole new lot of planes, well they're gonna have negative cash flow in that period, but that's not necessarily a bad thing. 'cause obviously they need the planes to operate their business as long as they've got the funds to manage that, that's okay. But you need to understand cashflow. So profit can actually be a lot more stable than cashflow because You can adjust it and smooth it over time.

Chris (19m 48s):

You can't do that with cash. Cash is what it is. And there'll be periods when the cash is negative that you know there's a lot of expenditure and then there'll be periods hopefully if it's a good business when there's plenty of excess cash. And you would've noticed that if you're looking at results of companies particularly last year, because what happened in the pandemic, a lot of companies were struggling with their supply chains and that, you know, they couldn't get the products that they needed to sell. So what they did is they started building up inventory. In other words, they bought more and more stock and held that as inventory. So what that meant was their cash went down and their what we call working capital, which includes inventory went up, that's fine, provided they can then sell that product.

Chris (20m 29s):

Where some did get into trouble was they bought all this inventory and then discovered no one wanted it and had to sell it at cheap prices to get rid of it.

Phil (20m 37s):

Yeah, I've said a couple of garages still full of toilet rolls.

Chris (20m 41s):

Exactly. Yeah,

Phil (20m 43s):

No, I just, the, the point of that question is that for long term investors, it's worth keeping in mind that markets are volatile and they'll go up and down quite significantly. But good businesses still survive that. And I guess it's just in terms of reassurance for when you see the screen full of red.

Chris (20m 59s):

Yeah, no absolutely, that's, that's a very important point and that is that businesses don't fluctuate day to day. Day-to-day markets might, but businesses generally the impacts on a business are fairly gentle except when you have these one-off major events, they're the types of things we talked about earlier that just can't be foreseen. But as a general rule, a business is fairly steady and but the market sentiment can be quite erratic.

Phil (21m 25s):

How does free cash flow growth, this is not just free cash flow, but the growth in that free cash flow indicate a company's ability to take care of its operations and reward shareholders.

Chris (21m 35s):

Yep. So ultimately cash is king, right? You've heard that saying suppliers and staff have to be paid in cash interest and debt has to be paid in cash. Lenders won't lend additional funds if they're not confident that a business is generating enough free cash flow. That in turn impacts a business's ability to invest for growth. So by growing free cash flow, it ensures that firstly operations are taken care of, but second debt obligations can be met. Third, the business can invest for future growth and finally and importantly, dividends can be paid for shareholders. Yeah, an example of where this didn't happen is Appen. So the stock code APX, if you've been following that company, you would've noticed in the last year and in the first half of this year their free cash flow turned negative and consequently they had to stop paying dividends.

Chris (22m 25s):

So ultimately if you're investing in a business for dividends, cash is essential. If the business stops generating cash, then those dividends are going to dry out.

Phil (22m 34s):

Can you share a real life example of a company with impressive free cash flow growth and how that growth translated to good news for investors? So we're looking in the past now, so this is not a recommendation to buy, this is just an example of something that worked despite the vagaries of forecasting.

Chris (22m 49s):

Yeah, absolutely. Yeah. One, and I do own this one I should say up front is Nick Scali, most people will have heard of Nick Scali, a furniture retailer. Their free cash flow has grown from 18 cents to a dollar 54 over the last five years. So that's really strong growth. And at the same time, dividends have grown at 13% per annum over that period. Right? So, and added to that, the share price has roughly doubled over the period. So the fact that that company can generate really solid cash and that cash is growing has led to them being able to pay really good dividends and the share price also rising.

Chris (23m 31s):

Now they've been able to invest in their business, right? So they've opened lots of new stores, they buy property which they then use for their stores or for distribution centers rather than just renting the property, they often buy their own. And about a year and a half ago they bought a business called plush sofas. So they were able to expand their business by a significant margin because they had the cash to acquire plush sofas. So the fact that you know, that business has had growing free cash flow has enabled the shareholders to really prosper.

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Phil (24m 48s):

Seven, investing long-term thinking without the mental anguish. What role does the quality of management play in this? Because obviously they must have excellent management to achieve that kind of growth.

Chris (25m 1s):

Yes, absolutely. I think management play a really key role. I mean, Anthony Scali is a, a really quality operator in the furniture space and he has built that business, he owns a large chunk of it and often it's good to align yourself with own founder manager because their interests are obviously to grow the business and you benefit from that provided they're doing the right thing by their smaller shareholders, And, you know, most do then it's often good just to get on that train with them. I think it's absolutely true. The managers have played a really key role in the success of that business and many others.

Phil (25m 41s):

Sometimes investors start thinking and trying to out guess themselves with what we call macro themes. And over the last couple of years with rising interest rates and mortgage pressures, there has been a narrative that companies like Nick Scali, which are consumer discretionary, is that correct? Correct.

Chris (26m 2s):


Phil (26m 2s):

That that they, they may suffer because people are going to be putting more of their funds into consumer staples rather than discretionary. Do you have any thoughts on that kind of idea? Yeah,

Chris (26m 16s):

I do. That's true. But you wanna interpret that sensibly. So the way I think about that is, yes, you know right now interest rates are going up. There may be a slowdown in housing, people may buy less sofas, will Nick Scali go broke? No, just look at their balance sheet. They're a really solid business. Will their profits decline? A little bit quite possibly, but if you're investing for the long term, then those are just opportunities, right? You can get the Shares at a cheaper price quite often during those periods. As a Freudian slip And, you know, I don't wanna talk too much about my own situation, but what I've done with that business, I bought it six, seven years ago and when we go through periods like this, I just top up a little bit when the market gets overexcited and the share price was $15 not that long ago I sold a little bit, but I basically enjoy the ride and it's the dividends that really have helped my, my Wealth accumulation over that period of time.

Chris (27m 19s):

And the other thing to bear in mind when it comes to these periods where yeah sure there'll be some pressure is the good businesses often take advantage of those. What can happen is the poorer businesses may go out the door and when we emerge on the other side of this period, the good businesses have actually increased their market share and are in an even stronger position than what they were previously. So I tend to be of the view that yeah, you've gotta be very confident that the business you've chosen is one of the good ones, but if it is and it's got a really solid balance sheet, minimal debt, then stick with it. Maybe even add to your stake and it'll come out the other side. We know that this sort of downturn period that we're currently going through is not gonna last forever and some forecasters think it's already over, so you know, don't get too anxious about that sort of thing.

Phil (28m 10s):

You referred to Nick Scali's balance sheet and that it's, it's a strong one that means there's not much debt,

Chris (28m 16s):

Correct? Yeah, that's right. So I remember back when, you know the world went crazy three years ago in covid and companies stopped earning revenue because we all had to stay at home. The first thing I did was just look at the balance sheet and said, well can they survive if they earn nothing, nothing over six months, can they survive? The answer was yes. Now obviously it's gonna hurt them, but that they were in a strong enough position that they would get through that and then be able to resume, you know, assuming that the world got back to normal within six months, which it sort of did.

Phil (28m 48s):

Are there any other simple financial metrics or factors that investors should consider alongside free cashflow?

Chris (28m 54s):

Yeah, well as you just mentioned, net debt to equity is one of the first things I look at 'cause I'm a cautious Investor. I also like to look at profit margins. So we're harping on about Nick Scali, but they have very solid profit margins and that means that, you know, if we go into a period where things are a bit negative, sure that profit margin might squeeze a bit, but it's not gonna go negative. They'll still make a profit on their sales. So understand margins. Now different businesses generate different margins. We know that like a supermarket will generate low single digit margins, but the more margin you have, the more room you have in, in terms of safety when, when things don't go so well.

Chris (29m 36s):

The other metric I look at is return on equity. That tells you how good is the business at generating a return on the funds that have been invested in it. And you want businesses that are being well managed and that's a, a good way to tell is, you know, are they squandering the money that they've been given or are they generating a good return on it?

Phil (29m 56s):

So where's a place for Beginners to start to find an understand free cashflow data? Are there any easy to use tools or resources you recommend for this purpose?

Chris (30m 4s):

Yeah, well I mean the annual report is the best place if you really wanna get into the detail, but of course reading annual reports is not simple and not always the most exciting thing to do. I did have a look at my broker, which is CommSec. They have cashflow per share, but they don't have free cashflow per share. Stockopedia, the system I represent covers both of those. So free cashflow as well as operating cashflow. There's probably some other tools as well. But you know, a, a tool like ours basically accumulates all that information and presents it in a very easy to read format. you know, You can see multiple years, so You can see the trend as well as today's numbers and that's what you're looking for.

Phil (30m 43s):

So what kind of trend are you looking for?

Chris (30m 45s):

Well you're looking for positive free cash flow, not necessarily every year, but over time you, it should be positive and ideally it should be growing as well

Phil (30m 54s):

In Stockopedia, can you screen just for free cash flow? Is that possible?

Chris (30m 57s):

Indeed, yes, You can. So how does that work? We have quite a, we have quite a, a comprehensive screener and You can choose from up to 350 metrics, including a whole bunch based around free cash flow. So you go in and you say something like, I want to see companies where free cash flow is greater than a certain amount or free cashflow growth is greater than a certain amount. And then it'll pull up a list of companies that meet that, that criteria and You can refine that from there.

Phil (31m 24s):

And of course this is not a predictive tool, is it by any means? you know, you've gotta take into account a lot of the other factors, you know, it's not just one metric that we're looking at, is it?

Chris (31m 33s):

No, that's right. No, absolutely. That's right. And we do have forecasts within the system. We don't actually forecast free cash flow and I should disqualify that. We don't forecast anything, but we bring in forecasts from market analysts but their forecasts around earnings or dividends.

Phil (31m 50s):

So if listeners wanna find out more about you and Stockopedia, where can they go? Yeah,

Chris (31m 54s):

Well we're a subscription product. You can go to au and set up a free trial of our product there and learn all about Wikipedia and how it can help you understand these metrics as well as many others.

Phil (32m 7s):

Chris Batchelor, thank you very much for jumping in at the last minute. I had some guests reschedule. So thank you very much for joining me today to help out and explain free cashflow, which I do feel a lot more confident in talking about.

Chris (32m 21s):

No worries, Phil, it's always great to be on the show. Thanks for having me. Thanks

Chloe (32m 25s):

For listening to Shares for Beginners. You can find more at Shares for Beginners dot com. If you enjoy listening, please take a moment to rate or review in your podcast player or tell a friend who might want to learn more about investing for their future.

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