I understand that eps is an important metric to look at when analyzing a company. (And I wont go into all the details of eps) But at the end of the day, the amount "you" have in "your" bank account, is FCF. So shouldn't FCF be more looked at. (AMZN is good example in its "beginning" years had low EPS and High FCF, due to its unique business model)
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If I promise to pay you $500 next week, should investors buy your shares today, or next week?– user20574Commented Jan 31, 2023 at 11:37
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If shares are trading below $500 let’s say $490 then do it today. Assuming you are completely confident I can pay the $500.– JackCommented Feb 3, 2023 at 2:40
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@user253751 but I don’t think that’s what you are trying to get at. Pls explain– JackCommented Feb 3, 2023 at 2:42
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and when everyone keeps buying the shares as long as they are less than $500, the share price goes up until it is $500, yes?– user20574Commented Feb 3, 2023 at 19:02
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1therefore the (total) share price would go up $500 if we earned $500 today even though it won't be cash until next week?– user20574Commented Feb 7, 2023 at 8:16
1 Answer
FCF typically refers to "free cash flow" and is a flow, not a stock, variable. So, there is no free cash flow at a point in time. FCF only exists over a period (month, quarter, year, etc.).
If you are referring to cash sitting on the balance sheet, that's simply an asset and one that is only responsible for generating free cash flow if it is required cash part of working capital.
Fundamentally value is driven by all future free cash flows discounted by the appropriate cost of capital, where free cash flow is defined as:
(Sales - Expenses - NonCash expenses) x (1 - TaxRate) + NonCash Expenses - Net Long-Term Investment - Net Working Capital Investment
So, if you want to understand the value of a company, you need to understand the value drivers embedded in free cash flows - sales, expenses, investment, and taxes - and the cost of capital - interest rates and risk premia.
As for Amazon, I'm not sure I agree that its free cash flow was high in the early years. It often had negative earnings and was investing, so negative free cash flow. What it was doing was raising a lot of equity capital to fill the void.
EPS, while informative, can also be misleading, because earnings is sensitive to risk. For example, a share repurchase will, on average, increase EPS because of the decline to the denominator but, because of the increase in leverage, will lead to riskier and therefore less valuable earnings.
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Good answer - could tie in the last paragraph to a general statement like "... that's why no single financial ratio provides a complete understanding of a company's performance, and more in-depth analysis is required." Commented Jul 17 at 12:59
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