Maximizing Returns: Leveraging Free Cash Flow in Tech Stocks
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Chapter 1: Understanding Free Cash Flow
Free cash flow (FCF) serves as a vital tool for investors seeking to identify high-performing tech stocks. This metric highlights companies with sufficient cash flow to engage in activities such as share buybacks, dividend payments, and strategic acquisitions while managing their debt effectively.
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Section 1.1: Defining Free Cash Flow
FCF represents the cash remaining after a company's operational expenses and capital expenditures (Capex) are accounted for. To calculate FCF, one subtracts Capex from operating cash flow.
Operating cash flow can be found in a public company's Statement of Cash Flow and is typically calculated by adjusting net income for non-cash expenses, such as depreciation and stock-based compensation. Many analysts prefer non-GAAP measures, including EBITDA (earnings before interest, taxes, depreciation, and amortization), which also factor into FCF calculations.
Free cash flow accounts for these adjustments but also deducts taxes, interest expenses, and changes in working capital and Capex. The resulting cash is considered "free" for value-adding activities like stock buybacks, dividends, acquisitions, and debt repayment.
This article will explore how FCF impacts various tech companies and how it can assist in selecting promising tech stocks.
Section 1.2: Amazon's Approach to Free Cash Flow
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Amazon (AMZN) places significant importance on its free cash flow, often highlighting it in its financial disclosures even before reporting revenue. In its latest earnings announcement, Amazon stated that its operating cash flow for 2020 reached $66 billion—an impressive 72% increase from the prior year. Subsequently, the company reported a free cash flow of $31 billion, reflecting a 20% rise from $25.8 billion in the previous year.
The calculation reflects Amazon's substantial capital expenditures of $40 billion, offset by $5 billion from asset sales. The calculated FCF yield of 1.9% (obtained by dividing $31 billion by its market capitalization of $1.59 trillion) can help project future stock valuations. For instance, if Amazon generates an estimated $47.3 billion in FCF this year, the projected market value could reach approximately $2.489 trillion, suggesting a potential share price of $4,853—58.7% above its current trading price of $3,057.
This video titled "Best Way to Value IT Stocks - How to Value Information Technology Stocks" will delve deeper into how to assess the value of tech stocks effectively.
Section 1.3: Facebook's Growing Free Cash Flow
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Facebook (FB) is another excellent example of a company generating substantial FCF. In the most recent quarter, Facebook reported a remarkable $9.22 billion in FCF, marking a 91% increase year-over-year. This data is readily available in its earnings release, making it easy for investors to track.
Additionally, the FCF for the last quarter represented a 55% increase compared to $5.95 billion from the previous quarter. The consistent rise in revenue from advertising contributes significantly to Facebook's capacity to produce FCF, which is likely to impact its stock price positively.
Based on projections, Facebook may achieve $32 billion in FCF for the year—an increase of 39% from last year's $23 billion. With a current FCF yield of 3.0%, the market value may rise to $1.066 trillion, reflecting a potential stock price of $361.13—an increase of 418% from current levels. If the market values Facebook's FCF similarly to Amazon's, its worth could reach $1.684 trillion, leading to a price of $569—123% higher than current levels.
The second video, "How to Value a Stock (2024 Updated with Example)," provides further insights into stock valuation using FCF.
Conclusion
In summary, free cash flow serves as a critical indicator for predicting the potential rise in tech stock prices. It also aids in assessing a company's ability to pay dividends or repurchase shares. By utilizing FCF yield, investors can set precise price targets for tech stocks that generate considerable free cash flow. As demonstrated with Amazon and Facebook, both companies are significant producers of free cash flow, suggesting that their stock prices are likely to rise in the future.
While this analysis offers insights, it is essential to conduct your own research before making investment decisions. Always apply your judgment and understanding when selecting stocks.