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The Complete List Of Hedge Fund Letters To Investors Q4 2023

Editorial Staff — Mon, 14 Feb 2022 15:26:18 +0000

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Every quarter, FinMasters curates an archive of quarterly hedge fund letters from all over the web.

These letters are from the top hedge funds and the most successful investment firms in the world – learn about the stock market, the economy, the global geopolitical landscape, and investing strategies and philosophy from the very best in the business today.

Many of the letters are sourced from Reddit/r/SecurityAnalysis but also include other sources. If you have any more hedge fund letters or reports – especially ones with a value investing focus – please send them here.

Enjoy the archive!

2023 Hedge Fund Letters

Q4 2023 Hedge Fund Letters

Value vs Growth Investing: What’s the Difference?

Dillon Jacobs — Thu, 01 Jan 2015 10:53:11 +0000

Imagine this scene:

A boxer sits in one corner of the ring, his shoulders hunched as his trainer pours water on his head, matting his greying hair across his forehead. He sits steady and still as his hands are wrapped and then taped into his gloves, as they’d been nearly a hundred times before.

He might be a veteran with experience, sure, but he’s old, and well past his prime and into the stage of his life when all of his peers have retired, most ages ago. Some would say he’s washed up, but this fighter knows he still has some strength left in him.

The crowd hisses and boos as the announcer booms his name over the PA system. He’s the underdog in this fight and is clearly unloved by the audience. Everyone’s betting against him. He doesn’t care.

His opponent stands in the corner opposite him, bouncing energetically on his toes. The young buck. The up-and-comer. The challenger to the throne. The young man’s muscles ripple as he punches his gloves together in front of him, ready for battle.

He looks strong and powerful. He turns toward the crowd and lifts his arms above his head, raising their cheers for him ever louder. They love him. They’re certain he’ll win by knock-out… the only question is in which round. They overlook the fact that he’s never been in a fight before. The boy’s a sure winner.

The fight described above is the same one that plays out every day on Wall Street, where “value investing” (the veteran boxer) is pitted against “growth investing” (the young gun) in the battle for superior returns.

It would seem that if you own a brokerage account, then you must sit squarely in one or the other camp. Indeed, the investment “style box” is ubiquitous in investment literature and stocks and portfolio managers alike are constantly pigeonholed into corners of that box.

You’re either one or the other – a “growth” investor or a “value” investor.

The classical definition of “value investing” is the strategy of selecting stocks that trade for less than their fundamental – or intrinsic – value. Value investors believe that the true worth of a stock and the price that is reflected everyday by the stock market, are not always the same and often can differ dramatically.

Diamonds in the Rough

Value investors proverbially “pay 50 cents to buy $1.” Generally they “focus on companies with lower-than-average sales and earnings growth rates” and stocks “with lower price-to-earnings and price-to-book ratios.” Value investors seek safety in exchange for lower returns. The prototypical “value” company operates in a mature industry. Value investors would pick the old-timer over the fresh-faced boxer.

The classical definition of “growth investing” on the other hand is the strategy of picking stocks of companies that are expected to experience faster than average growth as measured by revenues, earnings, or cash flow.

Growth investors are looking for the next “homerun stock” or the next “ten-bagger.” Growth investors tolerate more risk but are compensated with the potential for higher returns. Shares of most high-tech companies are considered “growth” stocks. Growth investors would choose the kid over the veteran.

However, at the end of the day this battle royale between “value” and “growth” investing doesn’t have a clear-cut winner. In fact, there is no winner at all, because there is no fight at all. See, the question to “Which is better, value or growth investing?” doesn’t have an answer because the question is fundamentally flawed.

Which Style is Right?

Value and growth investing are not enemies. They should not be thought of as contrasting strategies, on either end of some imaginary style spectrum.

Value vs Growth Investing: What's the Difference?

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Take this passage from Warren Buffett’s 1992 Berkshire Hathaway Shareholder Letter:

“But how, you will ask, does one decide what’s “attractive”? In answering this question, most analysts feel they must choose between two approaches customarily thought to be in opposition: “value” and “growth.” Indeed, many investment professionals see any mixing of the two terms as a form of intellectual cross-dressing.

We view that as fuzzy thinking (in which, it must be confessed, I myself engaged some years ago). In our opinion, the two approaches are joined at the hip: Growth is always a component in the calculation of value, constituting a variable whose importance can range from negligible to enormous and whose impact can be negative as well as positive.

In addition, we think the very term “value investing” is redundant. What is “investing” if it is not the act of seeking value at least sufficient to justify the amount paid? Consciously paying more for a stock than its calculated value – in the hope that it can soon be sold for a still-higher price – should be labeled speculation (which is neither illegal, immoral nor – in our view – financially fattening).

Whether appropriate or not, the term “value investing” is widely used. Typically, it connotes the purchase of stocks having attributes such as a low ratio of price to book value, a low price-earnings ratio, or a high dividend yield. Unfortunately, such characteristics, even if they appear in combination, are far from determinative as to whether an investor is indeed buying something for what it is worth and is therefore truly operating on the principle of obtaining value in his investments. Correspondingly, opposite characteristics – a high ratio of price to book value, a high price-earnings ratio, and a low dividend yield – are in no way inconsistent with a “value” purchase.

Similarly, business growth, per se, tells us little about value. It’s true that growth often has a positive impact on value, sometimes one of spectacular proportions. But such an effect is far from certain. For example, investors have regularly poured money into the domestic airline business to finance profitless (or worse) growth. For these investors, it would have been far better if Orville had failed to get off the ground at Kitty Hawk: The more the industry has grown, the worse the disaster for owners.

Growth benefits investors only when the business in point can invest at incremental returns that are enticing – in other words, only when each dollar used to finance the growth creates over a dollar of long-term market value. In the case of a low-return business requiring incremental funds, growth hurts the investor.”

What is Warren Saying?

For one, the classical definitions of value investing and growth investing as I described above don’t make any sense. To understand why, let’s first define each style by what it is not. If value investing is purchasing assets for less than their true value, then what is “growth investing”?

It is the opposite, or purchasing assets at a price greater than their true value. But paying more for a stock than it’s worth “in the hope that it can soon be sold for a still-higher price” is not investing at all – it’s speculation.

Even if a “growth investor” were to buy a “growth stock” that was supposed to grow earnings at an above-average rate, he or she would correspondingly have to pay a higher multiple for those earnings in the first place.

In other words, the growth rate of those earnings has already been baked into the purchase price (picture what happens if you increase the growth rate in a simple DCF analysis – present value increases). If that wasn’t the case, the stock would be worth more than the purchase price, which is the definition of value investing. Consequently, growth investing cannot exist: you’re either value investing or you’re speculating.

But now let’s look at “value investing” as defined earlier. If growth investing is purchasing shares of companies whose revenues or earnings are predicted to grow at an above average rate, then value investing is purchasing shares of companies whose revenues or earnings are predicted to remain flat or decline.

Now, this is not technically wrong. Value investors can certainly invest in companies whose earnings are flat or are declining. But it is merely a subset of all the strategies available to value investors.

The Ultimate Guide to Value Investing

Do you want to know how to invest like the value investing legend Warren Buffett? All you need is money to invest, a little patience—and this book. Learn more

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GEICO

Take a look at “the father of value investing” Benjamin Graham’s investment in The Government Employee Insurance Company (better known as GEICO). GEICO was founded in 1936. By 1940 the Company booked its first underwriting profit of $5,000. Graham started investing in the Company in 1948 and by the next year the Company’s profits exceeded $1 million. That’s an annual growth rate of over 90%. Ben Graham invented value investing, but GEICO looks like a “growth” investment to me.

Now let’s look at Graham’s greatest student, Warren Buffet, and his investment in GEICO. GEICO’s earnings eventually peaked in 1972, followed by 10 years of decline. The Company’s stock had hit a high of $61 per share in 1972 – a few years later it was trading at just above $2 per share. GEICO began reporting huge losses in 1975 and was on the brink of bankruptcy.

Buffett, who had first purchased stock in the Company back in 1951, started snapping up more shares and by 1980 had invested $45 million in GEICO. Okay, typical “value” investment. But today, GEICO now records profits of over $1 billion a year! Again, there’s no way that isn’t above average growth!

Common Sense

As Warren said in his 1992 Shareholder Letter, growth is merely a component in the calculation of the value of a stock, and it can be present or absent, and a positive or negative influence. So the common definition of “value investing” is already wrong, because value can also incorporate growth.

Secondly, the term “value investing” itself is redundant. “What is ‘investing’ if it is not the act of seeking value at least sufficient to justify the amount paid?” Remember, “price is what you pay, value is what you get.” The only way to make an above average return in any transaction is by giving up less than the value you are receiving.

This is pure common sense. There is no way that I would trade you three nickels for a dime – I’d trade you one nickel for a dime or at the very least a nickel and four pennies. That is investing; all else is speculation.

Despite the confusion caused by the media and finance professionals, who toss the term around without knowledge of its true meaning, the core tenets of value investing can be accurately summarized as follows:

1. Price is What You Pay, Value is What You Get

It’s all in the name. Above all else, value investors focus on the price they pay and its relationship to the value they are receiving in return. Many people forget that a stock is an actual partial ownership in a business and not just a paper certificate. As such, a stock’s true worth lies in the cash and economic value that the business is able to generate over time and not in the market’s quoted price.

In The Intelligent Investor, Benjamin Graham introduced a metaphor for this principle: Mr. Market. Mr. Market is a kind neighbor who stops by your house every day, offering to buy shares from you. Sometimes Mr. Market is in a wonderful mood and makes a generous offer. Other times Mr. Market is cranky and offers you a ridiculously low price.

Mr. Market also offers to sell shares of businesses to you, and always at a price that is dependent on his mood that day. You are always free to accept or decline his offer, for he will be back again the next morning.

Value investors do not pay much attention to the short-term fluctuations of the market, knowing that the true worth of a stock lies with the company itself, and not in a stockbroker’s hands.

Warren Buffett also has given sage advice on this matter: “I never attempt to make money on the stock market. I buy on the assumption that they could close the market the next day and not reopen it for five years.”

Value investors, above all else – and at their very primal core, know the price of everything, and the value of everything, and they only buy when the price is right.

2. Value Investors are Intelligent Investors

Don’t worry, this has nothing to do with SAT scores. As Warren Buffet has said, if you’ve got an IQ of 160, you’re better off selling 30 points to someone else because you won’t need them. This concept, introduced in Ben Graham’s The Intelligent Investor, is more about managing yourself than it is about managing your portfolio.

The key characteristics of intelligent investing are: a focus on price, as already mentioned; a detachment of your own emotions from the vicissitudes of the market; a reliance on hard facts and realizable historical performance, rather than hopeful projections and guesswork; and the concept of “margin of safety,” which is the difference between a stock’s intrinsic value and its market price.

Value investors seek out large margins of safety when investing.

“You don’t drive a truck that weighs 9,900 pounds across a bridge that says ‘Limit 10,000 pounds’ because you can’t be that sure. If you see something like that, go a little further down the road and find one that says, ‘Limit 20,000 pounds.’ That’s one you drive across.”

Ben Graham had a saying that I always liked: “You don’t need to know a man’s weight to tell him he’s fat.” In other words, the biggest margin of safety you can have when analyzing a stock is when you don’t even have to do any calculations to know it’s a good investment.

3. Choose Your Weapon

The traditional and common idea of “value investing” (as we discussed earlier) is the strategy of selecting stocks with low P/E or low P/B ratios. But there are many other strategies available to value investors, such as the following:

Net-nets: Finding stocks that are trading for less than their “net net working capital,” or for less than their current assets less total liabilities.

Deep value: Finding stocks with very large margins of safety.

Distressed: Investing in stocks or bonds of companies that are distressed or in the midst of bankruptcy.

Turnaround: Purchasing a control position in a company to effect operational changes or efficiencies, a strategy of some private equity shops.

Activist: Investors like Carl Icahn who acquire large stakes in companies and then lobby for changes in the Board of Directors, increased dividend payments, and/or share repurchases in an effort to release untapped value.

The Buffett Disciples: Buying amazing companies at good prices.“Growth at a reasonable price”: Peter Lynch’s strategy of buying high growth companies at an appropriate price.

Pawn Stars: Value investing can also be found outside of the financial world, such as in this History Channel TV show where a Las Vegas pawn shop tries to find, haggle for, and ultimately buy items for less than their true value.

Moneyball: Value investing has even found its way into sports. Billy Beane’s strategy of using certain statistics such as on-base percentage and slugging percentage to find baseball players that were “undervalued” by other teams (rather than the more popular and headline-grabbing stats like number of home runs and stolen bases) allowed the Oakland Athletics to become one of the best teams in baseball on a payroll that was only a third the size of many other teams’.

4. It’s Not a Strategy, It’s a Lifestyle

Value investing is not a strategy, as the common definition would have you believe. It’s a philosophy. It’s a lifestyle. Value investors believe in the price-to-value relationship and the importance of having a margin of safety down to the very marrow of their bones, and this belief is evident in all aspects of their lives.

Warren Buffett still lives in the same house he bought in 1958 for $31,500 and has worked in the same modest office building for over 50 years. Earlier in his career when he had business to do in New York City, he would stay with friends, sometimes for several weeks at a time, to avoid paying for a hotel room – despite the fact that he was a multimillionaire at this point.

The famous value investor Leon Cooperman drives his own car (as does Warren), buys his own newspaper every morning, and stays at a friend’s house instead of getting a hotel when he visits the Hamptons. Many value investors set up their investment shops as lean machines with few employees and little overhead – all in an effort to avoid wasting money.

It’s hard to say for certain if individuals are driven to value investing because of their personalities or if they develop their personalities because of value investing – but I tend to believe in the former. If it’s already part of your personality – if it’s in your DNA – then the concept of value investing should just “click.” Value investors are able to tune out the market noise and keep their wits about them while everyone else succumbs to fear and greed because it’s a part of who they are.

Let’s return to the boxing ring, where the veteran and the rookie are about to face off. With all that you now know about value investing, it doesn’t matter who wins the fight. The only thing that’s important is that you’re in the ring when the bell sounds.

The post Value vs Growth Investing: What’s the Difference? appeared first on FinMasters.

What Is the Buffett Indicator?

David Moadel — Wed, 20 Jul 2022 10:00:25 +0000

He’s been called the Oracle of Omaha, and even the greatest living value investor. Berkshire Hathaway CEO Warren Buffett is so highly regarded for his time-tested investment approach that he really needs no introduction. The Buffett Indicator, his somewhat less famous method for assessing overall market valuation, may require some explanation.

If the name Buffett is practically synonymous with value investing, then it makes sense that the Buffett Indicator has something to do with measuring value. Buffett is known to be plain-spoken, and the indicator that bears his name is simple yet surprisingly powerful.

A Well-Timed Warning

Buffett hasn’t often spoken directly on his methodology for gauging whether U.S. stocks, overall, are cheap, pricey, or somewhere in between. Fortunately, Fortune magazine recorded and archived a rare instance of Buffett directly addressing this topic at the turn of the millennium. As you may recall (if you’re old enough), this was a time when the Internet was relatively new to the public and the prevailing sentiment on Wall Street was that technology stocks could and would keep going up indefinitely.

This was a perfect time for Buffett to provide a warning that just maybe, the American stock market was a tad overvalued. He cited a ratio that would include “the market value of all publicly traded securities as a percentage of the country’s business – that is, as a percentage of GNP.”

After calling this ratio “probably the best single measure of where valuations stand at any given moment,” Buffett observed that at that time, “nearly two years ago the ratio rose to an unprecedented level. That should have been a very strong warning signal.”

Hindsight is always 20/20, but it’s certainly evident that Buffett was 100% right to raise a red flag about stock valuations. Unfortunately, it was only after the dot-com bubble burst in mid-2000 and the NASDAQ plunged more than 50% that some traders would learn a harsh lesson about the consequences of buying hype.

Breaking Down the Formula

The Buffett Indicator might have been a year or two early in heralding a stock-market crash, but there’s certainly value in gauging euphoria in the market. After all, it’s better to be too early in exiting a trade than too late.

While Buffett referred to GNP or gross national product (which calculates the total value of goods and services produced by U.S. residents domestically and abroad), economists have generally changed over to GDP or gross domestic product (which is limited to what’s produced by U.S. residents within the country’s borders). Today, GDP is often used as a rough-and-ready way to measure the value of what a nation is producing, and by inference, how economically healthy that nation is at that moment.

If GDP is the numerator of Buffett’s ratio, then the denominator would be “the market value of all publicly traded securities.” Now, this phrase might bring the S&P 500 to mind, but that index only comprises 500 large-cap companies. Instead, then, the denominator should be the Wilshire 5000 Total Market Full Cap Index, which the Federal Reserve acknowledges as a way to measure the total value of the U.S. stock market.

After dividing the current value of the Wilshire 5000 Total Market Full Cap Index by the nation’s GDP, you’ll probably end up with a decimal of some sort. Typically, this would be converted into a percentage by multiplying by 100. Voila – you’re now using the Buffett Indicator.

Buffet Indicator = Wilshire 5000 Total Market Full Cap Index / GDP

History Repeats Itself

Though Buffett might be a better investor than instructor, at least he provided some basic guidelines on how much is too much in regard to the Buffett Indicator. As he explained during the dot-com collapse, “If the percentage relationship falls to the 70% or 80% area, buying stocks is likely to work very well for you. If the ratio approaches 200% – as it did in 1999 and a part of 2000 – you are playing with fire. As you can see, the ratio was recently 133%.”

Indeed, the Federal Reserve’s iteration of the Buffett Indicator confirms that it was elevated above 100% prior to the bursting of the dot-com bubble. The Fed’s version of the Indicator didn’t approach 200% like Buffett’s version may have done in 1999-2000, but even exceeding 100% could mean that investors are “playing with fire.” After all, a reading above 100% seems to suggest that stocks are generally more expensive than they ought to be, given the health of the nation’s economy.

So, was the Buffett Indicator a reliable predictor of U.S. stock-market crashes after the dot-com collapse? Let’s take a closer look.

Source: Advisor Perspectives

The Buffett Indicator did indeed indicate that stocks were getting ahead of themselves prior to the next two crashes. For instance, the Fed’s version of the Indicator peaked above 100% in 2007’s third quarter, not long before the Great Recession that commenced in 2008.

The lead-up to the next stock-market crash is where the usefulness of the Buffett Indicator might be called into question. The Fed’s version of the Indicator topped 100% in the first quarter of 2013 – and, it has stayed above 100% since that time, including through the recession of 2020. Staying out of the stock market from early 2013 through today would have meant missing out on a large portion of one of the most lucrative bull markets in recent history.

Valuing a Valuation Metric

Buffett himself acknowledged that the ratio of the stock market’s value to the country’s GDP “has certain limitations in telling you what you need to know.” He didn’t provide much detail on those limitations at that time, but the aforementioned example of 2013 through 2022, at least, suggests that being too reactive to lofty Buffett Indicator readings could mean leaving a whole lot of money on the proverbial table.

The Buffett Indicator is a guide to whether the market as a whole is overvalued or undervalued, and will not help you assess the valuation of any specific stock or sector.

In the final analysis, then, the Buffett Indicator may be most useful when combined with common-sense observations of stock-market-versus-economy dynamics. Are share prices relentlessly going up even while businesses and people are struggling? Are corporate earnings lagging while retail traders are feverishly buying stocks (like they did in 1999)?

When the Buffett Indicator is going parabolic – and more importantly, when Wall Street doesn’t reflect what’s happening on Main Street – then just maybe, it’s time to choose prudence over profits.

The post What Is the Buffett Indicator? appeared first on FinMasters.

Warren Buffett’s Net Worth Over the Years

Dillon Jacobs — Wed, 07 Oct 2015 11:51:39 +0000

According to Forbes, Warren Buffett’s net worth in February 2024 is $126.3 billion. He is currently the 6th richest person in the world^[1].

Key Takeaways

Buffett started young. Warren Buffett reached millionaire status by 30, achieving early financial success through ambitious goal-setting and dedicated effort.
A billionaire at 55. Buffett became a billionaire at 55 and has been one for almost 40 years, through up and down markets.
A resilient strategy. Buffett recovered from a major financial setback in the 1970s, showing the importance of dealing with failure.

Warren Buffett’s Net Worth by Age

Warren Buffett hasn’t always been one of the richest men in the world. Warren Buffett didn’t even become a billionaire until he was 50 years old. In fact, 99% of Warren Buffett’s net worth was earned after his 50th birthday.

Warren Buffett always had big ambitions. His goal as a kid was to become a millionaire by the time he was 30. And he did it.

Here’s a look at Warren Buffett’s net worth over the years:

Click on the image to enlarge

Track stock picks and portfolio of Berkshire Hathaway, the holding company of Warren Buffett, to see which stocks he currently invests in: Warren Buffet Portfolio Tracker

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Cathie Wood (ARK Invest) Portfolio Tracker (Q3 2023)

Milica Aleksandric — Mon, 03 Oct 2022 16:00:14 +0000

This Cathie Wood portfolio tracker lists all publicly-traded U.S. stocks owned by Cathie Wood’s holding company, ARK Invest, as of December 31, 2023. It examines the top 50 holdings, their value, the share of the portfolio, and the changes in the company’s positions since the previous quarter.

Reporting Period: Q4 2023
Portfolio date: December 31, 2023
Number of holdings: 223
Portfolio value: $16,890,985,000

Cathie Wood Top 50 Holdings

Click the headers to sort the table

Number of Shares: The number of shares owned.
% of Portfolio: The weight of the shares relative to the total value of the fund’s portfolio.
Activity: The percent change in the number of shares owned compared to the previous quarter.
Reported Price: Price of the shares on the portfolio date as reported in the 13F filing.
Reported Value: The dollar value of the shares on the portfolio date.
Current Price: Current price of the shares.
Value Change: The difference between the reported value of the portfolio and the current value of the portfolio.

Cathie Wood Portfolio Value (2016- 2023)

The dollar value of shares in the ARK Invest portfolio on the reporting date (in thousands).

Cathie Wood Portfolio Tracker: Track stock picks and portfolio changes of the famous investor.

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About this Cathie Wood Portfolio Tracker

The data used in the Cathie Wood portfolio tracker was compiled from the most recent 13F filing submitted by ARK Invest on 01/17/2024. This data was reported to the Securities and Exchange Commission in a filing made available to the public.

These holdings may not represent the entirety of the ARK Invest portfolio. The SEC can and does grant permission to companies to temporarily withhold data on their holdings. The securities that institutional investment managers must report on Form 13F are “section 13(f) securities.” They do not have to disclose short positions, shares in mutual funds, holdings of fewer than 10,000 shares (or less than $200,000 principal amount of convertible debt securities), and less than $200,000 aggregate fair market value.

The post Cathie Wood (ARK Invest) Portfolio Tracker (Q3 2023) appeared first on FinMasters.

Investing in Foreign Stocks: What You Need to Know

Jonathan Schramm — Sat, 17 Sep 2022 16:00:00 +0000

The US stock market is the world’s largest capital market and offers an exceptional range of opportunities. Many foreign companies directly list their stock on US stock exchanges like the NYSE or the Nasdaq. If you’re interested in diversification, though, you should consider adding foreign-listed stocks to your portfolio.

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4 Best Dividend ETFs to Buy in 2024

TJ Porter — Sun, 16 Apr 2023 16:00:00 +0000

Dividends can add an important income stream to your portfolio, and dividend stocks tend to be resilient during downturns. If you have a limited amount to invest, though, buying individual dividend stocks may not get you the diversification you want. Dividend ETFs offer diversification in a highly liquid investment with the flexibility of trading at any time throughout the day

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What Is Free Cash Flow and How to Calculate It

Jonathan Schramm — Thu, 23 Jun 2022 10:00:05 +0000

Understanding free cash flow (FCF) is important for analyzing a company’s investment fundamentals. In this post, we will explore what free cash flow is, how to calculate it, and the ways to effectively use it in financial analysis.

Key Takeaways

Cash flow refers to the amount of money entering and leaving a company. It doesn’t take into account all expenses so it doesn’t necessarily reflect real costs.
This is the formula used to calculate Free Cash Flow: Cash Flow – Capital Expenditure (CAPEX).
Like with all financial calculations, using Free Cash Flow as a way to evaluate a company does come with risks, such as dilution of existing shareholders to CAPEX inconsistency and poor capital allocation.

What Are Cash Flows?

Before discussing “free” cash flow, we need to look quickly at the concept of cash flow. There are two ways to measure a company’s profitability. One is earnings and the other is cash flow.

Earnings are synonymous with after-tax net income. They are the sum of sales, minus all the costs and expenses of the company.

Cash flow is, as the name suggests, the quantity of money entering and leaving the company.

The difference between the two is that earnings take into account ALL expenses, including accounting conventions like depreciation and amortization. In theory, this gives a more accurate view of a company’s profits. But this can also be used by unscrupulous management to temporarily make a picture look better than it really is.

In contrast, cash flow is a lot more straightforward. The money is in the company or not. But this does not always reflect real costs, like the infrequent need to purchase land, offices, or industrial equipment.

This is why Free Cash Flow is preferred when valuing a company.

How to Calculate Free Cash Flow

Free Cash Flow is Cash Flow minus Capital Expenditure (CAPEX).

FCF is especially useful in companies operating capital-intensive industries, like mining, oil & gas, or manufacturing.

A big advantage of free cash flow is that it reflects the company’s ability to distribute profit to the shareholders. Dividends are taken from actual cash, not accounting fictions like earnings or even worse metrics like EBITDA (Earnings Before Interest, Taxes, Depreciation, and Amortization).

Another advantage is that a difference between FCF and net income can reveal problems. Management’s calculation of depreciation may not have honestly measured the company’s regular CAPEX spending needs. This can give misleading high earnings for a little while, but the real CAPEX spending will be included in the FCF calculation, and show the true situation.

The Risks of Using Free Cash Flow

Free Cash Flow is a useful way to evaluate a company. But like with all financial calculations, the devil is in the details.

One of the first things to check is to measure Free Cash Flow per share. If the company constantly issues new shares and dilutes existing shareholders, free cash flow growth will not profit the existing shareholders.

Another thing to pay attention to is CAPEX consistency. If the company spends capital very irregularly, the FCF calculation might be misleading. For example, if the company has paused CAPEX temporarily, this will boost FCF. But this CAPEX level is unlikely to be sustainable and will need to go up at a later date.

Lastly, capital allocation is important. A company can produce a lot of FCF, but squander it on ill-fated acquisitions, inefficient R&D, or unsuccessful expansion. In this case, the free cash flow is useless to shareholders, as it will never be distributed in the shape of dividends or buy-backs, or used to grow the business.

So overall, Free Cash Flow is useful if at least these 3 criteria are met:

Relatively stable share count.
Accurate estimation of future CAPEX needs and assessment of current CAPEX relative to the historical trend.
The company has a history of shareholder-friendly policy and good Return on Invested Capital (ROIC).

Any assessment of FCF has to start with establishing this basis.

Discounted Free Cash Flow

Discounted Free Cash Flow (DFCF) Analysis is a very popular valuation method widely used in value investing. It’s a complicated technique and a full explanation would require a much more detailed article, but we can look at the basic idea.

DFCF analysis uses the current free cash flow plus its expected growth over time and uses that figure to project the value of that cash flow in the future. That cash flow is “discounted”: for each future year, the current value of that future cash flow gets smaller.

The discount is designed to adjust for something called the time value of money. A dollar a year from now is less valuable than a dollar today because the dollar today can be used to earn more money over the course of the year. The discount rate is larger the farther into the future you project.

One of the principles of value investing is that a company’s legitimate value is the value of all its future cash flow, making DFCF analysis a very good way to judge if a stock is undervalued. This is especially useful for a company with plenty of growing FCF.

The limitations of this method fall into 2 categories:

Current Free Cash Flow may not reflect the true profitability of the company (see above.
Predictions about the future are hard, and the DFCF model can be very wrong if you misjudge the growth rate.
Growth rates may depend on external factors that are difficult to predict. Analysis of a company must be matched with an effective analysis of the industry and the wider economic environment.

DFCF analysis can be an effective tool, but to use it effectively you will need to study it at a level much deeper than this introduction. As with all analysis techniques, you’ll need to maintain awareness of its limitations.

This article from the Corporate Finance Institute gives a detailed explanation of how to calculate DFCF. If the calculations are too complex, use our Discounted Free Cash Flow Calculator!

Conclusion

Free Cash Flow (FCF) is a very useful tool to measure the long-term value of a company. Like all other tools, it needs to be used with a touch of common sense and good judgment.

In many circumstances, it is more relevant and gives a more accurate picture of a company’s profit than earnings. This is because earnings are easier to manipulate and are under more scrutiny by analysts. There is simply more incentive to optimize a company’s financials toward showing good earnings.

You will still need to be careful in your assessment of whether current and projected cash flow accurately represents the long-term prospects of the company. That means looking carefully at the company’s quality, its management’s skills and ethics, and the wider industry and economic environment.

Discounted Free Cash Flow models are as well useful, but vulnerable to error. They rely heavily on multiple assumptions about the future; especially growth rate and a stable economic environment. They can be used to evaluate a company’s current valuation, but should not be taken as an absolute truth about the company’s intrinsic value.

The post What Is Free Cash Flow and How to Calculate It appeared first on FinMasters.

What Are Tax-Advantaged Retirement Accounts?

Adina Lazar — Fri, 12 Feb 2021 11:01:00 +0000

Starting early with tax-advantaged retirement accounts can make a significant difference in your retirement planning. Tax-advantaged retirement accounts are a favored vehicle for retirement savings, and understanding the various types available is the first step. Over half of Americans don’t know how a 401(k) works^[1]. Most of us pretend we do and nod along. At this point, many of us are afraid to ask.
To help you, we will review the different types of tax-advantaged retirement accounts without all the complicated financial jargon.

Key Takeaways

Start Early for Compound Growth: Begin contributing to tax-advantaged retirement accounts as soon as possible to maximize their earning potential through compound growth.
Understand Different Account Types: Learn about the various types of accounts (like Traditional IRA, Roth IRA, 401(k)s) to find the one best suited to your financial situation and retirement goals.
Consult a Professional for Tailored Advice: Given the complexity of these accounts, seek advice from a financial advisor to make informed decisions that align with your long-term financial plans.

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How to Buy Boring Company Stock in 2024: What You Need to Know

Steve Rogers — Tue, 15 Nov 2022 17:00:25 +0000

When Tesla and SpaceX founder Elon Musk launches a new venture, investors pay attention. Investors have been wondering how to buy Boring Company stock since the Company’s launch in Dec. 2016.

The Boring Company intends to shake up urban transportation by moving it underground, making the construction and deployment of underground transport systems faster, cheaper, safer, and more efficient.

That goal has obvious appeal, and if the Company can pull it off it could have a remarkable future.

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