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Free cash flow per share is as important as earnings per share

Updated: Mar 18

If you look at Earnings Per Share, then you should not ignore Free Cash Flow Per Share.


Earnings Per Share (EPS) is an important profitability metric, but as investors, we should never overlook Free Cash Flow Per Share (FCFPS).


FCFPS is another profitability metric that divides a company's free cash flow by the number of common shares outstanding.


Free Cash Flow Per Share = (Operating Cash Flow - Capital Expenditures) / (Shares Outstanding)


In other words, this measures a company's ability to pay debts, pay dividends, buy back stocks, and facilitate the growth of the business.


Many investors consider Free Cash Flow Per Share to be a better measure of a company's financial flexibility, which is its ability to react to unexpected expenses and investment opportunities.


So why you should not ignore Free Cash Flow Per Share?


This is because, a company’s FCFPS is a more reliable value than a company's EPS, which can be manipulated through accounting practices. Cash flows present the true picture, but earnings can be manipulated.


Net income is calculated after the company generates revenues. However, sales or services provided are often made on credit. For example, the company can record a sale made but only collect cash six months later. This increases the earnings but has no cash inflow. It is also calculated after deducting the cost of depreciation and amortisation (non-cash expenses).


All these factors can inflate or deflate the value of net income artificially.


On the other hand, cash flows are influenced by the company's cash from operations, which gives investors an insight into the core of a company's cash-generating machine. Henceforth, higher revenue, lower overhead, and more efficiency are huge drivers of cash flow from operating activities. Cash can also help companies expand, develop new products, buy back stocks, pay dividends, or reduce debts.


Knowing this, one notable application of the Free Cash Flow Per Share is that it can be used to confirm a company’s EPS growth year-on-year due to greater profitability and cash flows rather than accounting tricks.


For example, you can see below that as S&P Global Inc’s Earnings Per Share rises, the company’s Free Cash Flow Per Share increases as well. We can affirm that the company’s EPS growth is due to greater profitability and cash flows rather than accounting tricks.


If you look at Earnings Per Share, then you should not ignore Free Cash Flow Per Share | The Globetrotting Investor | Stock Investing | Value Investing
Source: Gurufocus

For creditors, a low FCFPS means weak solvency and it will be risky to provide loans for the company.


Lastly, investors can use FCFPS to give a preliminary prediction regarding its future share prices.


When a company’s share price is low, but FCFPS is increasing, the share price has a higher chance of rising. This is because high FCFPS will mean that the EPS should potentially be high as well, which is typically followed by an increase in share price.


Bottom Line


While Earnings Per Share is an important profitability metric, Free Cash Flow Per Share is a more credible value to measure a company's financial strength. The next time you analyse a company, do not forget to look at its Free Cash Flow Per Share.

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