Why understanding fundamental analysis is important for investing in stocks?

Fundamental analysis:

Why understanding FA is important? 

FA cannot offer you the magic keys to sudden or instant wealth. If that were true, the Professors of Finance will all be fabulously rich! What FA can do is to provide sound principles for formulating a successful long-range investment program. FA are proven methods that have been used by millions of successful investors.

The motivation for investing in stocks is obvious. It is to watch your money grow.

Why then, for every story of great success in the market, there are dozens more that don't end so well!!!!

More often than not, most of those investment flops can be traced to:

1. Bad timing
2. Poor planning
3. Failure to use common sense in making investment decisions.



Intrinsic Value

The entire concept of stock valuation is based on the idea that all securities possess an intrinsic value that their market value will approach over time.

Security analysis consists of gathering information, organizing it into a logical framework, and then using the information to determine the intrinsic value of common stock.

Given a rate of return that's compatible with the amount of risk involved in a proposed transaction, intrinsic value provides a measure of the underlying worth of a share of stock. It provides a standard for helping you judge whether a particular stock is undervalued, fairly priced or overvalued.



Main message

The aims of fundamental analysis are to determine the asset's intrinsic value and its future growth potential.

Income Stocks

Income Stocks

Income stocks are appealing simply because of the dividends they pay.

These issues have a long history of regularly paying higher than average dividends.

Income stocks are ideal for those who seek a relatively safe and high level of current income from their investment capital.



Growing dividends protect from effects of Inflation

Holders of income stocks (unlike bonds and preferred stocks) can expect the dividends they receive to increase regularly over time.

Thus, a company that paid, say, $1.00 a share in dividends in 1997 would be paying just over $1.80 a share in 2012, if dividends had been growing at around 4% per year.

Dividends that grow over time provide investors with some protection from the effects of inflation.



Major Disadvantage: some have Limited Growth Potential

The major disadvantage of income stocks is that some of them may be paying high dividends because of limited growth potential.

Indeed, it is not unusual for income securities to exhibit relatively low earnings growth.

This does not mean that such firms are unprofitable or lack future prospects.

Quite the contrary:   Most firms whose share qualify as income stocks are highly profitable organizations with excellent prospects.

A number of income stocks are among the giants of U.S. industry, and many are also classified as quality blue chips.




Risks

By their nature, income stocks are not exposed to a great deal of business and market risk.

They are, however, subject to a fair amount of interest rate risk.

Examples

Many public utilities are in this group, such as:

• American Electric Power,
• Duke Energy,
• Oneok,
• Scana,
• DTE Energy, and 
• Southern Company.

Also in this group are selected industrial and financial issues like:

• Conagra Foods,
• General Mills, and
• Altria Group.

Blue-Chip Stocks

"Blue chips are companies that pay a dividend and increase it over time."

Blue Chips

Blue chips are the cream of the common stock crop.

They are stocks issued by companies that have a long track record of earning profits and paying dividends.  

Blue-chip stocks are issued by large, well-established firms that have impeccable financial credentials.

These companies are often the leaders in their industries.




Not all blue chips are alike.

Some provide consistently high dividend yields; others are more growth oriented.

While blue-chip stocks are not immune from bear markets, they are less risky than most stocks.

They tend to appeal to investors who are looking for quality, dividend-paying investments with some growth potential.

Blue chips appeal to investors who want to earn higher returns than bonds typically offer without taking a great deal of risk.



Examples:

Good examples of blue chip growth stocks are:

• Nike,
• Procter & Gamble,
• Home Depot,
• Walgreen's,
• Lowe's Companies, and 
• United Parcel Service.

Examples of high-yielding blue chips include such companies as:

• AT&T,
• Chevron,
• Merck,
• Johnson & Johnson,
• McDonald's, and 
• Pfizer.

The Advantages of Stock Ownership

1.  Possibility for substantial returns

One reason stocks are so appealing is the possibility for substantial returns that they offer.

Stocks generally provide relatively high returns over the long haul.

Common stock returns compare very favourably to other investments such as long-term corporate bonds and U.S. Treasury securities.

Over the last century, high-grade corporate bonds earned annual returns that were about half as large as the returns on common stocks.

Although long term bonds outperform stocks in some years, the opposite is true more often than not.

Stocks typically outperform bonds, and usually by a wide margin.

Stocks also provide protection from inflation because over time their returns exceed the inflation rate.

In other words, by purchasing stocks, you gradually increase your purchasing power.



2.  Ease of buying and selling

Stocks are easy to buy and sell, and the costs associated with trading stocks are modest.



3.  Information easily available

Information about stock prices and the stock market is widely disseminated in the news and financial media.



4.  Cost to own stocks is low.

The unit cost of a share of common stock is typically fairly low.    

Unlike bonds, which normally carry minimum denominations of at least $1,000 and some mutual funds that have fairly hefty minimum investments, common stocks don't have such minimums.

Most stocks are priced less than $50 a share and you can buy any number of shares that you want.





Additional notes:

Investors own stocks for all sorts of reasons:
1.  the potential for capital gains,
2.  their current income, or
3.  perhaps the high degree of market liquidity.

The Disadvantages of Stock Ownership

There are some disadvantages of common stock ownership.

1.  Risk

Risk is perhaps the most significant.

Stocks are subject to various types of risk, including:

• business and financial risk,
• purchasing power risk,
• market risk and 
• event risk.

All of these can adversely affect 

• a stock's earnings and dividends, 
• its price appreciation and 
• of course, the rate of return that you earn.

Even the best of stocks possess elements of risk that are difficult to eliminate because company earnings are subject to many factors, including:

• government control and regulation,
• foreign competition and
• the state of the economy.

Because such factors affect sales and profits, they also affect stock prices and (to a lesser degree) dividend payments.

2. Price & Returns Volatility

All of this leads to another disadvantage: stock returns are highly volatile and very hard to predict, so it is difficult to consistently select top performers.

The stock selection process is complex because so many elements affect how a company will perform.

In addition, the price of a company's stock today reflects investors' expectations about how the company will perform.

In other words, identifying a stock that will earn high returns requires that you not only identify a company that will exhibit strong future financial performance (in terms of sales and earnings) but also that you can spot that opportunity before other investors do and bid up the stock price.

3. Current income

A final disadvantage is that stocks generally distribute less current income than some other investments.

Several types of investments - bond, for instance - pay more current income and do so with much greater certainty.

Comparing the dividend yield on common stocks with the coupon yield on high grade corporate bonds from 1976 to 2012,  shows the degree of sacrifice common stock investors make in terms of current income.

Clearly, even though the yield gap has narrowed a great deal in the past few years, common stocks still have a long way to go before they catch up with the current income levels available from bonds an most other types of fixed-income securities.

Message:  

In other words, identifying a stock that will earn high returns requires that:

• you not only identify a company that will exhibit strong future financial performance (in terms of sales and earnings) 
• but also that you can spot that opportunity before other investors do and bid up the stock price.

Uses of Common Stocks: as storehouse of value, to accumulate capital and as a source of income

Basically, common stocks can be used as:

1.  a "storehouse" of value,
2.  a way to accumulate capital, and,
3.  a source of income.


Storage of value

Storage of value is important to all investors, as nobody like to lose money.

However, some investors are more concerned about losses than are others.

They rank safety of principal as their most important stock selection criterion.

These investors are more quality-conscious and tend to gravitate toward blue chips and other non-speculative shares.


Accumulation of capital

Accumulation of capital, in contrast, is generally an important goal to those with long-term investment horizons.

These investors use the capital gains and/or dividends that stocks provide to build up their wealth.

Some use growth stocks for this purpose, while others do it with income shares, and still others us a little of both.


Source of income

Finally, some investors use stocks as a source of income.

To them, a dependable flow of dividends is essential.

High-yielding, good-quality income shares are usually their preferred investment vehicle.




Individual investors can use various investment strategies to reach their investment goals.

These include:

1. buy and hold,
2. current income,
3. quality long term growth,
4. aggressive stock management, and 
5. speculation and short term trading.

The first 3 strategies appeal to investors who consider storage of value important.

Depending on the temperament of the investor and the time he or she has to devote to an investment program, any of these strategies might be used to accumulate capital.

In contrast, the current income strategy is the logical choice for those using stocks as a source of income.

Singapore investors lost over S$1 mil to online binary options scams

SINGAPORE (Dec 15): Singapore police has issued a warning over a “sharp rise” in scams involving online trading in binary options.

The Commercial Affairs Department (CAD) has received more than 30 reports from investors who have lost more than S$1 million to unregulated binary options trading platforms, authorities said in a press release on Wednesday.

Police said most victims are local Chinese males aged between 31 and 50, and include finance professionals as well as retirees.

“Binary options trading is attractive, because it sounds simple and the option providers or platforms often promise high, quick and safe returns,” police said in its statement. “In reality, binary options are speculative and risky, and many online platforms offering binary options trading are fraudulent.”


All or nothing

With a binary option, investors try to predict whether the price of the underlying asset will be above or below a specified price at a specified point in time.

That specified point in time is usually very near, ranging from a few minutes to a few months in the future.

Meanwhile, the underlying products can range widely, and include shares, currencies and commodities.

Unlike other types of options, holding a binary option does not give the investor the right to buy or sell the underlying asset. Investors receive a fixed payoff, if their prediction is correct, but lose the entire investment if they are wrong.

“That is why binary options are often also called ‘all or nothing’ options,” police said. “The risk of losing your entire investment is high, because correctly predicting short term price movements is difficult.”

Singapore investors lost over S$1 mil to online binary options scams

An investigation by Money Mail and the Bureau of Investigative Journalism found that the vast majority of binary option traders never make any money from it.

Some eight in 10 customers are reported to end up losing all their cash within five months. At some binary firms, the investigations revealed that just three in 100 customers ever make a profit.

Lured by initial profits and promises of financial advice, more bonuses and attractive rewards, most of the investors found it difficult to stop at one small investment and would put in more money.

In Singapore, these investors either lost all their monies or could not withdraw the balances in their accounts, police said.

Some also had unauthorised withdrawals made in their debit or credit cards after they had handed over their card details for payment.

Authorities said most of the binary options trading platforms encountered were usually unregulated entities based outside Singapore.

When things go wrong, the victims faced difficulties contacting these foreign operators, who commonly claim to be operating from the United Kingdom, Cyprus and Hong Kong.


Beware of scams

Police urged Singaporeans to exercise caution and keep in mind the following when dealing with binary options trading:

a) Even when offered by legitimate sellers, binary options trading is a high risk investment where you can easily lose all that you invested.

b) Investments which promise high returns usually come with high risks. Think carefully before making the investment. When in doubt, seek professional advice before engaging in any investment products.

c) Dealing with unregulated entities mean you may have very little recourse if things go wrong.

To find out which entities are regulated in Singapore, check the list of capital markets services licence holders under Monetary Authority of Singapore (MAS) and the list of licensed commodity brokers under International Enterprise (IE) Singapore.

You may also like to check the MAS Investor Alert List, which provides a listing of unregulated entities which may have been wrongly perceived as being licensed or authorised by MAS.

d) Even if you are dealing with an entity regulated in Singapore, some binary options offered by that regulated entity may not be regulated. This means that you may have minimal recourse if things go wrong. When in doubt, you should check with the regulated entity before investing in any binary option it offers.

e) Be wary of third party reviews, endorsements or success stories of binary option providers. These reviews and endorsements may have been paid for by the binary option providers. They may also attempt to gain your trust by warning you against a particular binary option provider while directing you to another binary option provider connected to them.

f) Be cautious of high pressure sales tactics used by representatives of binary option providers. These tactics include promises of quality financial advice or easy profits.

g) Be careful when sending money to overseas bank accounts via fund transfers, debit or credit card payments, and any other modes of payment. Always ensure that the end recipient is reliable before making any transfers or payments.

Likewise, do not give your personal particulars such as your name, identification number, passport details, bank account or credit and debit card details to others without first verifying whether they are legitimate.

http://www.theedgemarkets.com/my/article/singapore-investors-lost-over-s1-mil-online-binary-options-scams

ROE as a proxy for Competitive Advantage

The DuPont formula

ROE= (Net Profit/ Sales) X (Sales/ Assets) X (Assets/ Equity)

And we are left with:   

ROE = Net Profit/ Equity

The DuPont breakdown goes on to show why ROE is such a critical ratio for analysts and investors alike. 

It basically is combination of three ratios that reflect overall profitability and efficiency of a company. 

This breakdown also shows the bearing of six factors on ROE instead of the usual two that we assume are the beginning and end of it.

ROE as a proxy for Competitive Advantage:

Consistently High RoE figures do indicate that the company has a moat. 

As seen above in the Dupont breakdown of RoE, a company can have a high RoE 

• either because it is able to sell its goods/services at a high margin 
• or because  increase its returns by either selling its products at a high rate. 

Only the third option is undesirable i.e having a high leverage which would mean high indebtedness . 

Remember, we said a consistently high levels of RoE to be construed as an evidence of a moat. 

This is because the denominator of this ratio includes shareholders equity which in turn consists of   share capital plus retained earnings (also called reserves and surplus)

Share holder's equity= Share capital + Retained earnings

Now as the company generates higher returns on equity, the profits are added to the retained earnings. 

So the denominator of ROE keeps increasing and so either the company has to

•  keep showing growth in its profits or 
• find ways to reduce the denominator. 

The company can do that by 

• either paying higher dividends 
• or buying back shares

- both strategies lead to gains for shareholders. 

http://www.investorwhiz.com/concepts/return-on-equity-roe

Working capital management is the main determinant in the liquidity position of a company.

Liquidity or Working Capital Ratios

Cash Conversion cycle is just one part of assessing the working capital position. 

Other is the computation of 

• Current Ratio, 
• Acid-test Ratio and 
• Cash Ratio. 

Current Ratio

Current Ratio is the basic and the most used amongst the list of liquidity ratios. 

It is also known as working capital ratio and is stated as below:

Current Ratio= Current Assets/ Current Liabilities

The resultant figure represents the number of times current assets cover current liabilities. 

Higher the ratio better it is. 

However, this ratio can be higher even if cash is trapped in receivables and inventories.

Acid Test Ratio

Acid test ratio is also known as quick ratio and it considers only “highly” liquid assets in consideration.

Acid Test ratio = (Current Assets- Stock- prepaid expenses)/ Current Liabilities

Acid test ratio doesn't include inventories but does include receivables and so thought a refinement of current ratio may still mislead at times

Cash Ratio

This one is a further refinement of Acid Test ratio and considers only Cash and cash equivalents for the purpose of measuring liquidity. 

Cash Ratio = Cash + Cash equivalents / Current liabilities

The above ratios and Cash Conversion Cycle determine the working capital position of a company. 

However, we always maintain that one aspect of the entire financial position cannot be considered as representative of the total financial health of a company. 

So here are a few cautionary words for cases when you just have working capital figures to contend with.

Factors to consider when assessing working capital position of a Company

1.    Healthy and unhealthy working capital position can be generalized only according to the industry and sector an entity is operating in. Some entities by nature have higher liquidity and some low;

2.    Higher liquidity is not always favourable as it may indicate under-utilisation of resources and money. You will need to further dig in to find if this is the case;

3.    Consider recent sale, purchase, construction of an asset, pre-closure of loan or liquidation of a big liability owing to strategic decisions that affect liquidity tremendously;

4.    Change in trade terms, seasonal nature of goods sold also has a strong bearing on liquidity position.

Working capital management is extremely important for companies. 

It is the main determinant in the liquidity position of a company. 

Profitable companies can go bankrupt due to a paucity of liquidity.  

http://www.investorwhiz.com/concepts/understanding-working-capital

Components of Cash Conversion Cycle

Cash Conversion Cycle (CCC)

Cash Conversion cycle is the time taken by a trading or manufacturing concern to realise cash from its inventory and account receivables after meeting its outflows owing to short term payables including trade creditors. 

It is expressed in terms of number of days and can be defined as follows in form of a formula:-

CCC= Days’ Inventory Outstanding (DIO) + Days’ Sale Outstanding (DSO) – Days’ Purchase Outstanding (DPO)

Components of Cash Conversion Cycle - DIO, DSO and DPO

Days’ Sale Outstanding (DSO)

DSO is the measure to assess the number of days a concern gives credit to its customers. Let us explain it with a formula:
DSO= Average receivables/ daily sale
Where
Average receivables: Opening balance + Closing Balance/2
Daily sales: Total annual sale/365

DSO can be calculated for every month as well. In fact when there is a revamp of credit terms then DSO should be computed for every month to understand the implication and drop or hike in DSO, as the case may be.

Days’ Purchase Outstanding (DPO)

DPO gives average credit term (days of credit) enjoyed by a concern from its trade creditors. In term of formula, it can be stated as follows:
DPO= Average payables/ Daily purchases
Where,
Average payables= Opening balance+ Closing Balance/2
Daily purchases= Total purchases/365
Just like DSO, DPO can also be computed monthly or any period of time as required.

Importance and usage of DSO and DPO

Now that we have discussed the meaning of DSO and DPO, let us understand their implication on a business and cash conversion cycle. 

Ideally, every trading concern must try to have a bigger DPO and smaller DSO, which essentially implies that they recover cash from debtors in shorter duration and pay off their creditors later.

For e.g. ABC Company has a DSO of 30 days and DPO of 40. This gives an advantage of 10 extra days to ABC Company to meet its payables and it enjoys healthy liquidity to meet its other production and day to day expenses as well.

DSO comparisons also help in effective credit control. If without any re-negotiations, a company observes that its DSO has risen then it means that the collection process is not working well. This situation can be rectified in many ways including putting processes like advance reminders and water tight system of invoicing in place for the starters. If a company has indeed renegotiated terms with both debtors and creditors, then the month on month DSO and DPO comparisons would show the result in line with such re-negotiations.

Days’ Inventory Outstanding (DIO)

The third pillar of CCC deals with inventory. DIO is the average days a trading concern takes to convert its inventory into sale and is stated as follows:
DIO= Average Inventory/ Day’s Cost of goods sold
Where,
Average inventory= Opening Balance + Closing Balance/2
Day’s cost of goods Sold (COGS)= Cost of goods sold/365
If the accounting period for which DIO is to be computed is shorter, then day’s COGS will be computed for such other period and 365 days will get replaced accordingly.

An Example

Cash Conversion Cycle (CCC) 

= (DIO + DSO) – DPO 
= (44 + 33) - 61

= 16 days

The above computation shows that the average days of credit granted by XYZ Corp is almost half at 33 days as compared to the credit days lent by it, which is 61 days.

The average days it takes XYZ Corp to sell its stock is 44 days and the number of days in which it converts its inventory and debtors into cash is just 16 days.

These figures picture a very liquid position of XYZ Corp where it is able to meet its able to generate working capital very efficiently.     

Ideally, every trading concern must try to have a bigger DPO and smaller DSO, which essentially implies that they recover cash from debtors in shorter duration and pay off their creditors later.

http://www.investorwhiz.com/concepts/understanding-working-capital

Understanding Working Capital

1. The above figure shows a typical working capital cycle. 
2. Cash is used to purchase raw materials . 
3. The raw materials are then turned into finished goods and sold to customers, usually for a credit period. 
4. Ultimately payment is received in cash from the customer and the cycle repeats. 

Sometimes working Capital can turn negative but before jumping to conclusion about it let us discuss it in length.

What Does Negative Working Capital Mean?

Now the first conclusion about negative working capital would be low efficiency and fact that an entity needs external funding even for day to day operations. 

But having excess of short term liabilities over short-term assets is not always unfavourable. 

• A sudden surge in creditors or dip in debtors can be result of one-off bulk payments and adjustments that make working capital negative but for a short period of time.  

A negative working capital which sustains over extended period is definitely a cause of concern.

• It could be because the finished product is being sold at very low margins or loss. This strategy is sometimes followed by companies who are looking at either increasing their market share or introducing new products. 
• Another instance is sizeble bad debts where debtors have gone bankrupt or refused to pay.  In such a situation the debtors will have a write-off which would result in a dip in current assets. 
• Loss in inventory by accident can also lead to negative working capital. 

But for example- financing a fixed asset by cash will make a hit at current assets position but it is a sign of efficiency where you are able to make investment in fixed assets by using internally generated funds!

• So this is an instance of a favourable negative working capital.

Working capital is a critical factor to consider in assessing the financial health of any business vis. a vis. the efficient use of its resources. 

http://www.investorwhiz.com/concepts/understanding-working-capital

Principles of Portfolio Planning

Investors benefit from holding portfolios of investments rather than single investments.

Without necessarily sacrificing returns, investors who hold portfolios can reduce risk.

Surprisingly, the volatility of a portfolio may be less than the volatilities of the individual assets that make up the portfolio.

When it comes to portfolios and risk, the whole is less than the sum of its parts!



Investment Goals

A portfolio is a collection of investments assembled to meet one or more investment goals.

Different investors have different objectives for their portfolios.

The primary goal of a growth-oriented portfolio is long-term price appreciation.

An income-oriented portfolio is designed to produce regular dividends and interest payments.




Portfolio Objectives

Setting portfolio objectives involves definite tradeoffs, such as the tradeoff

• between risk and return or 
• between potential price appreciation and income.

How you evaluate these tradeoffs will depend on your tax bracket, current income needs, and the ability to bear risk.

The key point is that your portfolio objectives must be established BEFORE you begin to invest.

The ultimate goal of an investor is an efficient portfolio, one that provides the highest return for a given level of risk.

Efficient portfolios are not necessarily easy to identify.

You usually must search out investment alternatives to get the best combinations of risk and return.

An Acceptable Level of Risk

Individuals differ in the amount of risk that they are wiling to bear and the reurn that they require as compensation for bearing that risk.


1.  The risk-indifferent investor requires no change in return for a given increase in risk.

2.  The risk-averse investor requires an increase in return for a given risk increase.

3.  The risk-seeking investor gives up some return for more risk.


The majority of investors are risk averse.

The historical data on the risk and return of different investments from all over the work indicate that riskier investments tend to pay higher returns.

This simply reflects the fact that most investors are risk averse, so riskier investments must offer higher returns to attract buyers.



How much additional return is required to convince an investor to purchase a riskier investment?

The answer to that question varies from one person to another depending on the investor's degree of risk aversion.

A very risk-averse investor requires a great deal of compensation to take on additional risk.

Someone who is less risk averse does not require as much compensation to be persuaded to accept risk.

Determining a Satisfactory Investment

Time value of money techniques can be used to determine whether an investment's return is satisfactory given the investment's cost.

Ignoring risk at this point, a satisfactory investment would be one for which the present value of benefits (discounted at the appropriate discount rate) equals or exceeds its cost.



The three possible cost-benefit relationships and their interpretations follow:

1.  If the present value of the benefits equals the cost, you would earn a rate of return equal to the discount rate.

2.  If the present value of benefits exceeds the cost, you would earn a rate of return greater than the discount rate.

3.  If the present value of benefits is less than the cost, you would earn a rate of return less than the discount rate.



You would prefer only those investments for which the present value of benefits equals or exceeds its cost - situations 1 and 2.

In these cases, the rate of return would be equal to or greater than the discount rate.

Dividend - An Easy Pill to Swallow

On the first trading day of 2016, the stock of a company XYZ, sold for $33.66 per share, just 1.6% higher than its price exactly 1 year earlier ($33.16).

Though it might seem that 2016 was a poor year for company XYZ's shareholders, the stock paid dividends during the year totalling $1.52 and those dividends raised the total return on company XYZ in 2016 to 6.2%.

Why Return is Important

An asset's return is a key variable in the investment decision because it indicates how rapidly an investor can build wealth.

Naturally, because most people prefer to have more wealth rather than less, they prefer investments that offer high returns rather than low returns if all else is equal.

However, the returns on most investments are uncertain, so how do investors distinguish assets that offer high returns from those likely to produce low returns?

One way to make this kind of assessment is to examine the returns that different types of investments have produced in the past.


Historical Performance

Most people recognize that future performance is not guaranteed by past performance, but past data often provide a meaningful basis for future expectations.

A common practice in the investment world is to look closely at the historical record when formulating expectations about the future.

Cash Flow from Financing Activities

This is where the company reports the money that it took in and paid out in order to finance its activities. 

In other words, it calculates how much money the company spent or received from its stocks and bonds. 

This includes 

• any dividend payments that the company made to its shareholders, 
• any money that it made by selling new shares of stock to the public, 
• any money it spent buying back shares of its stock from the public, 
• any money it borrowed, and 
• any money it used to repay money it had previously borrowed.

http://www.investorguide.com/article/11625/the-three-parts-of-cash-flow-statements-explained-igu/

Cash Flows from Investing Activities

This section shows how much money the company has received (or lost) from its investing activities. 

It includes 

• money that the company has made (or lost) by investing its excess cash in different investments (stocks, bonds, etc.), 
• money the company has made (or lost) from buying or selling subsidiaries, and 
• all the money the company has spent on its physical property, such as plants and equipment.

http://www.investorguide.com/article/11625/the-three-parts-of-cash-flow-statements-explained-igu/

Cash Flows from Operating Activities

This is how much money the company received from its actual business operations.

This does not include cash received from other sources, such as investments. 

To calculate the cash flow from operating activities, the company starts with net income (from the income statement), then adds back in any 

• depreciation expenses, 
• deferred taxes, 
• accounts payable and accounts receivables, and 
• one-time charges.

http://www.investorguide.com/article/11625/the-three-parts-of-cash-flow-statements-explained-igu/

Free Cash Flow

While free cash flow doesn't receive as much publicity as earnings do, it is considered by some experts to be a better indicator of a company's bottom line. 

Free cash flow is the amount of cash that a company has left over after it has paid all of its expenses, including investments. 

Whereas earnings reports are subject to a number of different accounting tricks which can artificially boost the bottom line, free cash flow is not. 

It is quite possible, for example, for a company to have positive earnings and negative free cash flow. 

Negative free cash flow is not necessarily an indication of a bad company, however; many young companies tend to put a lot of their cash into investments, which diminishes their free cash flow. 

But if a company is spending so much cash, you should probably be investigating 

• why it is doing so and 
• what sort of returns it is earning on its investments.

http://www.investorguide.com/article/11625/the-three-parts-of-cash-flow-statements-explained-igu/