how to define good free cash flow
fortunately most financial websites provide a summary of fcf or a graph of fcf s trend for most public companies however the real challenge remains what constitutes good free cash flow many companies with very positive free cash flow also have dismal stock trends and the opposite can also be true using the trend of fcf can help you simplify your analysis one important concept from technical analysts is to focus on the trend over time of fundamental performance rather than the absolute values of fcf earnings or revenue essentially if stock prices are a function of the underlying fundamentals then a positive fcf trend should be correlated with positive stock price trends on average a common approach is to use the stability of fcf trends as a measure of risk if the trend of fcf is stable over the last four to five years then bullish trends in the stock are less likely to be disrupted in the future however falling fcf trends especially fcf trends that are very different compared to earnings and sales trends indicate a higher likelihood of negative price performance in the future this approach ignores the absolute value of fcf to focus on the slope of fcf and its relationship to price performance example of free cash flowconsider the following example in this example there is a strong divergence between the company s revenue and earnings figures and its cash flow based on these trends an investor would be on alert that something may not be going well with the company but that the issues haven t made it to the so called headline numbers such as revenue and earnings per share these issues can be attributed to several potential causes a company could have diverging trends like these because management is investing in property plant and equipment to grow the business in the previous example an investor could detect that this is the case by looking to see if capex was growing between 2019 and 2021 if fcf capex were still upwardly trending this scenario could be a good thing for the stock s value low cash flows can also be a sign of poor inventory control a company with strong sales and revenue could nonetheless experience diminished cash flows if too many resources are tied up in storing unsold products a cautious investor could examine these figures and conclude that the company may suffer from faltering demand or poor cash management a change in working capital can be caused by inventory fluctuations or by a shift in accounts payable and receivable if a company s sales are struggling they may choose to extend more generous payment terms to their clients ultimately leading to a negative adjustment to fcf alternatively perhaps a company s suppliers are not willing to extend credit as generously and now require faster payment that will reduce accounts payable which is also a negative adjustment to fcf in the late 2000s and early 2010s many solar companies were dealing with this exact kind of credit problem sales and income could be inflated by offering more generous terms to clients however because this issue was widely known in the industry suppliers were less willing to extend terms and wanted to be paid by solar companies faster 1in this situation the divergence between the fundamental trends was apparent in fcf analysis but was not immediately obvious by examining the income statement alone 