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Computershare Limited (ASX:CPU) shareholders, and potential investors, need to understand how much cash the business makes from its core operational activities, as well as how much is invested back into the business. What is left after investment, determines the value of the stock since this cash flow technically belongs to investors of the company. I will take you through CPU’s cash flow health and the risk-return concept based on the stock’s cash flow yield, using the most recent financial data. This will help you think about the company from a cash perspective, which is a crucial factor to investing.
What is free cash flow?
Computershare’s free cash flow (FCF) is the level of cash flow the business generates from its operational activities, after it reinvests in the company as capital expenditure. This type of expense is needed for Computershare to continue to grow, or at least, maintain its current operations.
There are two methods I will use to evaluate the quality of Computershare’s FCF: firstly, I will measure its FCF yield relative to the market index yield; secondly, I will examine whether its operating cash flow will continue to grow into the future, which will give us a sense of sustainability.
Free Cash Flow = Operating Cash Flows – Net Capital Expenditure
Free Cash Flow Yield = Free Cash Flow / Enterprise Value
where Enterprise Value = Market Capitalisation + Net Debt
Computershare’s yield of 3.75% indicates its sub-standard capacity to generate cash, compared to the stock market index as a whole, accounting for the size differential. This means investors are taking on more concentrated risk on Computershare but are not being adequately rewarded for doing so.
Is Computershare’s yield sustainable?
Another important consideration is whether this return is likely to be maintained over the next couple of years. We can gauge this by looking at CPU’s expected operating cash flows. In the next few years, the company is expected to grow its cash from operations at a double-digit rate of 14%, ramping up from its current levels of US$514m to US$588m in three years’ time. Furthermore, breaking down growth into a year on year basis, CPU is able to increase its growth rate each year, from 0.2% in the upcoming year, to 6.6% by the end of the third year. The overall picture seems encouraging, should capital expenditure levels maintain at an appropriate level.
Given a low free cash flow yield, on the basis of cash, Computershare becomes a less appealing investment. This is because you would be better compensated in terms of cash yield, by investing in the market index, as well as take on lower diversification risk. However, cash is only one aspect of investing. Keep in mind that cash is only one aspect of investment analysis and there are other important fundamentals to assess. I recommend you continue to research Computershare to get a more holistic view of the company by looking at:
- Valuation: What is CPU worth today? Is the stock undervalued, even when its growth outlook is factored into its intrinsic value? The intrinsic value infographic in our free research report helps visualize whether CPU is currently mispriced by the market.
- Management Team: An experienced management team on the helm increases our confidence in the business – take a look at who sits on Computershare’s board and the CEO’s back ground.
- Other High-Performing Stocks: If you believe you should cushion your portfolio with something less risky, scroll through our free list of these great stocks here.
To help readers see past the short term volatility of the financial market, we aim to bring you a long-term focused research analysis purely driven by fundamental data. Note that our analysis does not factor in the latest price-sensitive company announcements.
The author is an independent contributor and at the time of publication had no position in the stocks mentioned. For errors that warrant correction please contact the editor at firstname.lastname@example.org.