If you are currently a shareholder in First Derivatives plc (LON:FDP), or considering investing in the stock, you need to examine how the business generates cash, and how it is reinvested. 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 FDP’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.
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What is First Derivatives’s cash yield?
First Derivatives generates cash through its day-to-day business, which needs to be reinvested into the company in order for it to continue operating. What remains after this expenditure, is known as its free cash flow, or FCF, for short.
The two ways to assess whether First Derivatives’s FCF is sufficient, is to compare the FCF yield to the market index yield, as well as determine whether the top-line operating cash flows will continue to grow.
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
First Derivatives’s yield of 8.9% last year indicates its ability to produce cash at the same rate as the market index, taking into account the company’s size. However, given that the risk for holding single-stock First Derivatives is higher, this may mean inadequate compensation above and beyond merely investing in the whole market.
Is First Derivatives’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 FDP’s expected operating cash flows. Over the next few years, the company is expected to grow its cash from operations at a double-digit rate of 42%, ramping up from its current levels of UK£20m to UK£28m in two years’ time. Although this seems impressive, breaking down into year-on-year growth rates, FDP’s operating cash flow growth is expected to decline from a rate of 26% next year, to 13% in the following year. However the overall picture seems encouraging, should capital expenditure levels maintain at an appropriate level.
First Derivatives is compensating investors at a cash yield similar to the wider market portfolio. But, in saying this, investors are taking on more risk by buying one single stock as opposed to a diversified market portfolio, but they are being compensated at the same level. Not the best deal! Now you know to keep cash flows in mind, I recommend you continue to research First Derivatives to get a more holistic view of the company by looking at:
- Valuation: What is FDP 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 FDP 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 First Derivatives’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 email@example.com.