Company ABC.
1995 Earnings $100,000 FCF -$7.0 million
1996 Earnings $5.9 million FCF -$28.0 million
1997 Earnings $12.3 million FCF -$57.4 million
Nice growth in earnings, right?
FCFs also grew - but in the opposite direction as earnings.
Company ABC's capital spending as a percentage of its long-term assets has been as high as 43%.
Company OPQ.
1997 Earnings $6,945 million FCF +$5,507 million
1998 Earnings $6,068 million FCF +$5,634 million
1999 Earnings $7.932 million FCF +$7,932 million
Nice growth in earnings, right?
FCFs also grew - but in this case, in tandem or the same direction as earnings.
Company OPQ has an annual capital spending of $3 billion or so, and its long-term assets are about $12 billion. That spending works out to 25% of its long-term assets, a pretty high figure.
Company DEF
1996 Earnings $1,473 million FCF - $2,532million
1997 Earnings $787 million FCF - $2,347 million
1998 Earnings $ 28 million FCF - $2,187 million
Company DEF's revenues actually declined during this period.
FCFs were consistently negative for the same period.
Company DEF spends an amount equal to about 20% of its long-term assets in a single year.
What really hurts is when a company spends aggressively but its performance stinks.
If a company is spending like mad, it had better be increasing its sales - and its profits - at a rapid rate.
Company ABC and Company OPQ pass that test.
Company DEF doesn't.
Company DEF is a mature company and for it to generate such meager free cash flows is bad enough.
But when a company spends an amount equal to about 20% of its long-term assets in a single year, you expect to see rapid growth. Yet, Company DEF's revenues actually declined during this period; the company's long-term record of growth is poor when you consider how much money gets plowed into the company.
