Looking for possible investment candidates: Four simple rules when comparing FCFps with EPS

 Summary

Expenses and depreciation reduce profits.  Capex reduces FCF.

When expenses are not expensed against revenues but considered as capex, the company will report higher profit.  Also, the depreciation charge reported by the company will be probably too low.

In a nutshell:

• the cash spent should be expensed against revenues and so it should reduce profits.  
• unless it does, this, the depreciation charge reported by the company is probably too low and profits too high.   

Four simple rules when comparing FCFps with EPS when looking for possible investment candidates:

1.  Definite candidate:  FCFps is 80% or more of EPS

2.  Possible candidate:  FCFps less than 80% of EPS and ROCE is increasing

3.  Avoid:  FCFps less than 80% of EPS but ROCE is falling 

4.  Avoid:  FCFps is consistently negative.