A Wealth of Common Sense: Talk Your Book: Investing in Free Cash Flow

Investors have a variety of tools that they can use when evaluating a company’s performance. Typically in markets, investors look at the price to earnings ratio, or PE.

While that’s a common tool, it’s one that may not always work in every situation. That’s because accounting  tools can allow earnings to look very different from the money that comes in the first place.

Looking at different tools can help investors find alternative opportunities.

For instance, free cash flow is a metric that can give a sense of a company’s profitability. Unlike earnings, accounting changes can’t lead to wild swings that turn profits into losses.

Free cash flow is different from net income, which looks at a company’s gross income after expenses.

When investors focus on companies with free cash flow, they can find opportunities that trade at a discount relative to looking at a company based on earnings.

Investors can even look at companies with high free cash flow and then look for ones that have strong growth. That provides a value metric and a growth metric that combine for better returns.

Companies with high free cash flow also have the ability to pay dividends or make big share buybacks. Those tools can also help push shares higher over time. That makes free cash flow a valuable metric for evaluating a stock investment.

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