Two important questions to ask before you buy Microgen plc (LON:MCGN) is, how it makes money and how it spends its cash. After investment, what’s left over is what belongs to you, the investor. This also determines how much the stock is worth. Today we will examine MCGN’s ability to generate cash flows, as well as the level of capital expenditure it is expected to incur over the next couple of years, which will result in how much money goes to you.
What is free cash flow?
Free cash flow (FCF) is the amount of cash Microgen has left after it pays off its expenses, including its net capital expenditures, which is what the company needs to spend each year to maintain or grow its business operations.
There are two methods I will use to evaluate the quality of Microgen’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
Along with a positive operating cash flow, Microgen also generates a positive free cash flow. However, the yield of 3.03% is not sufficient to compensate for the level of risk investors are taking on. This is because Microgen’s yield is well-below the market yield, in addition to serving higher risk compared to the well-diversified market index.
Does Microgen have a favourable cash flow trend?
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 MCGN’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 50%, ramping up from its current levels of UK£8.5m to UK£13m in two years’ time. Although this seems impressive, breaking down into year-on-year growth rates, MCGN’s operating cash flow growth is expected to decline from a rate of 36% next year, to 11% in the following year. But the overall future outlook seems buoyant if MCGN can maintain its levels of capital expenditure as well.
Low free cash flow yield means you are not currently well-compensated for the risk you’re taking on by holding onto Microgen relative to a well-diversified market index. However, the high growth in operating cash flow may change the tides in the future. 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 Microgen to get a better picture of the company by looking at:
- Valuation: What is MCGN 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 MCGN 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 Microgen’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.
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If you spot an error that warrants correction, please contact the editor at firstname.lastname@example.org. This article by Simply Wall St is general in nature. It does not constitute a recommendation to buy or sell any stock, and does not take account of your objectives, or your financial situation. Simply Wall St has no position in the stocks mentioned. Thank you for reading.