Warren Buffett, arguably the world’s best investor, once said that “to value something, you simply have to take its free cash flows from now until kingdom come and then discount them back to the present using an appropriate discount rate.” That illustrates the importance of a company’s Free Cash Flow in determining how valuable the firm is to an investor. Free Cash Flow, in essence, tells us the amount of actual cash that theoretically accrues to shareholders after a company has spent the necessary amounts needed to maintain its business’s current competitive position (the ‘necessary amounts’ are…
Warren Buffett, arguably the world’s best investor, once said that “to value something, you simply have to take its free cash flows from now until kingdom come and then discount them back to the present using an appropriate discount rate.”
That illustrates the importance of a company’s Free Cash Flow in determining how valuable the firm is to an investor.
Free Cash Flow, in essence, tells us the amount of actual cash that theoretically accrues to shareholders after a company has spent the necessary amounts needed to maintain its business’s current competitive position (the ‘necessary amounts’ are sometimes known as Capital Expenditures).
Management of companies can use the Free Cash Flow that’s generated to buy back shares, grow the business, strengthen the balance sheet, or pay out dividends. These are, in general, all beneficial actions for shareholders.
Mathematically, it is given by the equation:
Free Cash Flow = Cash Flow From Operations – Purchase of Plant, Property & Equipment (or Capital Expenditure)
Because of its importance, we’ll ideally like to see companies with Free Cash Flow that makes up a high percentage of its Sales. The higher the percentage, the more cash a company can earn per dollar of sale in which it can then use to beef up shareholders’ wallets.
Here are three companies – Vicom (SGX: V01), Raffles Medical Group (SGX: R01) and SIA Engineering (SGX: S59) – that have, on average, produced Free Cash Flows that make up double digit percentages of their Sales over their last four completed financial years.
Majority-owned by transport company ComfortDelgro (SGX: C52), Vicom’s probably well-known among Singaporeans for its vehicle inspection operations. But, that’s not all. It also does “quality assurance testing and evaluation of building materials, structural and chemical analysis, food and microbiological analysis, [and] environmental monitoring, among others” under its SETSCO umbrella.
The company’s second quarter results, released earlier last month saw its revenue for the quarter jump by 11% to S$26.6m while profits grew by 8.3% to S$6.9m.
Its shares are currently trading at S$4.72, representing a trailing Price-to-Free-Cash-Flow (P/FCF) ratio of 14.3 and a dividend yield of 3.9% based on the full-year pay-out of S$0.182 per share for its last completed financial year.
Raffles Medical Group
The company operates its flagship Raffles Hospital, along with a host of medical centers, in Singapore. In addition, RMG also runs a total of four medical centers in Shanghai and Hong Kong.
Its latest second quarter results, released on July, saw healthy double digit growth across its top and bottom-line. Sales for the quarter were up 13% year-on-year to S$86.8m while profits grew at an even faster pace of 15.7% to S$14.5m.
Shares of RMG are currently changing hands at S$2.98 apiece, carrying a trailing P/FCF ratio of 24.7 and a dividend yield of 1.5% based on its last completed financial year’s full-year pay-out of S$0.045 per share.
SIA Engineering is a subsidiary of Singapore’s flagship carrier, Singapore Airlines (SGX: C6L) and it does maintenance, repair, and overhaul (commonly abbreviated as MRO) work for aircrafts with a clientele that spans over more than 80 international carriers.
The company’s latest earnings results, for the first quarter of its financial year, saw a slight reduction in both its quarterly sales and profit. The former slipped 3.7% year-on-year to S$289m while the latter shrank by 1.6% to S$69m.
SIA Engineering’s shares are currently worth around S$4.60 a pop. Its P/FCF ratio stands at 50 and it paid out a dividend of S$0.22 per share for its last completed financial year, giving it a historical dividend yield of 4.8%.
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The information provided is for general information purposes only and is not intended to be personalised investment or financial advice. Motley Fool Singapore contributor Chong Ser Jing owns shares in Raffles Medical Group.