Why Stable Free Cash Flow Growth Matters

Free Cash Flow is typically defined as Operating Cash Flow minus Capital Expenditures. It is the cash that is left to either reinvest or to pay stakeholders with (e.g. through interest and/or dividend).

When investing, what we are typically doing is trying to make sure that any money that we invest, we get back plus an additional sum, such that we end up with a positive return. If a company generates a decent amount of cash, that could be a good indication that we get our money back. If it grows its cashflows, than intuitively we might get a little extra on top.

Of course, there is other characteristics to consider as well. We wouldn't want to pay too much (e.g. a too high of a stock price) relative to the Cash Flows. But for now let's dive into Cash Flow growth.

Does Stable Free Cash Flow Growth 'work' as a factor?

Does stable free cash flow growth have predictive value?

Let's do a ranking test, where we rank all companies based on Stable Free Cashflow Growth. We use the formula as defined here.

Performing a ranking of all companies by Long Term Stable Free Cash Flow Growth —demonstrates that this metric offers predictive value.

Another way of representing this is to look at the returns at the end of the period. As you can see, most of the spread in terms of returns is due to the lowest ranking buckets (where the lowest ranking companies are in), show a terrible return.

We can also represent it by the annual excess returns. As below. We probably should avoid companies that do not have stable free cash flow characteristics.

Should you use Stable Free Cash Flow Growth?

Most likely, yes.

Though there are other measures of a company's attractiveness that should probably have priority. We can see that stable Free Cash Flow growth is a metric that shouldn't be disregarded.

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Over the last 5 years I have been making 40%+ returns. Some of my top holdings are NATR, ESP and VLGEA.

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