Cash is King

Confusion that never stops
The closing walls and the ticking clocks
Gonna come back and take you home
I could not stop, that you now know
--Coldplay

There are many ways to value securities, but I'm biased towards those based on free cash flow. Free cash flow (FCF) is cash flow in excess of that required to fund all projects that have positive net present values when discounted at the relevant cost of capital (Jensen, 1986: 323). Stated another way, it's the cash that is 'free' for distribution to shareholders after all investments have been financed (Stewart, 1991: xvii).

FCF is what should matter to an investor. The investor's essential question should be, "Based on the capital that must go into an enterprise, how much can I get out?"

Truly, a 'fundamental' investment question...

A FCF approach can be handy for valuing stocks of publicly traded companies--particularly well established enterprises. However, valuing companies like General Electric (GE), Exxon (XOM), or even Google (GOOG) on a FCF basis seems to be a dying (or at least dormant) practice.

Perhaps we can kickstart the process in future missives.

References

Jensen, M.C. (1986). Agency costs of free cash flow, corporate finance, and takeovers. Amercian Economic Review, 76: 323-329.

Stewart, G.B., III (1991). The quest for value. New York: HarperCollins.