Free Cash Flow Seeing Through the Accounting

The purpose of this book is to explain Free Cash Flow and how to use it to increase investor return. The author explains the differences between Free Cash Flow and GAAP earnings and lays out the disadvantages of GAAP EPS as well as the advantages of Free Cash Flow. After taking the reader step-by-step through the author's Free Cash Flow statement, the book illustrates with formulas how each of the four deployments of Free Cash Flow can enhance or diminish shareholder return. The book applies the conceptual building blocks of Free Cash Flow and investor return to an actual company: McDonald's. The reader is taken line-by-line through the author's investor return spreadsheet model: (1) three years of McDonald's historical financial statements are modeled; (2) a one-year projection of McDonald's Free Cash Flow and investor return is modeled. Five other restaurant companies are compared to McDonald's and each other using both Free Cash Flow and GAAP metrics.

George C. Christy, CFA, has more than thirty years' experience in the financial markets. He has served as corporate banker for Fortune 500 and middle market companies, as well as treasurer of a publicly owned telecommunications equipment manufacturer. Christy has a BA from Princeton University and an MBA from the University of Chicago, and holds the Chartered Financial Analyst (CFA) designation. He is a member of the Los Angeles Chapter of Financial Executives International, the CFA Institute, the CFA Society of Los Angeles, the Japan America Society, and the International House of Japan.

Foreword	p. xv
Preface	p. xix
Investing 101	p. 1
Price	p. 1
Free Cash Flow	p. 2
Risk and Return	p. 3
The Return Multiple	p. 4
Return and Price	p. 4
Debt	p. 6
Equity	p. 9
Debt versus Equity	p. 11
Private Company versus Public Company	p. 12
The Accounting Fog Machine	p. 15
GAAP: Competing Theories, Matters of Opinion, Political Compromises	p. 16
GAAP: Accrual Abuse	p. 17
GAAP: Errors Bred by Complexity	p. 17
GAAP'S Gap	p. 18
GAAP EPS: An Incomplete Definition of Financial Performance	p. 18
GAAP EPS: Investing in an Economic Vacuum	p. 18
EBITDA is Not a Cash Flow Metric	p. 19
The GAAP Cash Flow Statement	p. 19
Beware the Balance Sheet	p. 20
Liquidity	p. 21
Fixed Assets and Depreciation	p. 21
Leverage and Debt Service	p. 22
Whose Return on Equity?	p. 22
The Notes	p. 23
When Do Accruals Meet Cash Flows?	p. 23
What is to be Done?	p. 24
Free Cash Flow	p. 25
Reconciliation of Net Income and Free Cash Flow	p. 25
Free Cash Flow versus Net Income	p. 27
A Universal Definition?	p. 28
Academic Research and the Discounted Cash Flow Model	p. 29
Barron's Rankings	p. 30
Buy-Side Users	p. 31
Private Equity Firms	p. 31
Warren Who?	p. 31
A Vast Media Conspiracy?	p. 32
FASB Staff Findings	p. 32
FAS 95: A Cruel Rule	p. 33
EPS Misses: The Real Deal	p. 33
An Alternative to the Government Number	p. 34
The Free Cash Flow Statement	p. 35
Building the Free Cash Flow Statement	p. 35
Four Key Questions	p. 40
Revenues	p. 41
Operating Cash Flow	p. 43
Working Capital	p. 44
Capex	p. 45
Capex: Magnitude and Risk	p. 46
Capex and Capital	p. 47
Capex Transfer	p. 48
Capex Visibility	p. 48
Capex and Investor Return	p. 49
Free Cash Flow	p. 49
Free Cash Flow Yield	p. 50
Free Cash Flow Deployment	p. 53
Acquisitions	p. 54
Buybacks	p. 56
Dividends	p. 59
Debt	p. 60
Projecting Investor Return	p. 61
The Free Cash Flow Worksheet	p. 65
Worksheet Features	p. 66
Entering Historical Data	p. 68
Adjustments to GAAP Cash Flow	p. 68
Operating Cash Flow	p. 71
Capex	p. 71
From the Balance Sheet	p. 72
The Free Cash Flow Statement	p. 73
GAAP Data	p. 74
Percentages	p. 75
Per Share Data	p. 76
Incremental Data and Company's Reinvestment Return	p. 77
Cash Sources and Deployments	p. 78
Acquisitions	p. 80
Buybacks	p. 80
Dividends	p. 81
Debt	p. 82
Operations	p. 82
Projecting Free Cash Flow	p. 83
Projecting Cash Sources	p. 86
Projecting Acquisitions	p. 87
Projecting in Share Value Due to ¿ in the Number of Shares	p. 88
Projecting Investor Return from Dividends	p. 90
Projecting in Share Value Due To ¿ in Debt	p. 91
Projecting in Share Value from Operations	p. 94
GAAP Data, Percentages, and Per Share Data	p. 94
Incremental Data and Company's Reinvestment Return	p. 95
Investor Return Projection	p. 96
Return Multiple	p. 98
Adding Periods to the Worksheet	p. 100
Using the Worksheet	p. 100
Six Companies	p. 101
Revenues	p. 102
Percentage Change in Revenues	p. 102
Operating Cash Flow Margin	p. 103
Capex as a Percentage of Revenues	p. 105
Free Cash Flow Margin	p. 106
Free Cash Flow Per Share	p. 107
The Government Number	p. 109
Net Nonworking Capital Items	p. 109
McDonald's	p. 111
Panera Bread	p. 113
Applebee's	p. 114
P.F. Chang's Bistro	p. 115
Cheesecake Factory	p. 116
IHOP	p. 118
Three Musketeers without New Unit Capex	p. 121
Whose Return on Equity?	p. 121
Sell-Side Analysts	p. 124
Total Returns	p. 125
Take Your Pick	p. 125
The CEO and Investor Return	p. 129
The CEO's Letter to Shareholders	p. 129
The Quarterly Earnings Conference Call	p. 135
The CEO's Incentive Compensation	p. 137
Chapter	p. 9
The Nine Steps	p. 145
Diversification for Individual Investors	p. 150
Equity Mutual Funds	p. 151
Free Cash Flow and Bonds	p. 152
Free Cash Flow and the Financial Crisis of 2008	p. 152
Equations	p. 153
McDonald's Income Statement	p. 159
McDonald's Balance Sheet	p. 162
McDonald's ROIIC and Weighting	p. 164
McDonald's ROIIC Calculations	p. 165
Recommended Reading	p. 168
Notes	p. 171
Acknowledgments	p. 174
About the Author	p. 175
About the Website	p. 176
Index	p. 177
Table of Contents provided by Ingram. All Rights Reserved.

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Free Cash Flow Seeing Through the Accounting Fog Machine to Find Great Stocks

Summary

Author Biography

Table of Contents

Supplemental Materials