Two important questions to ask before you buy Altium Limited (ASX:ALU) is, how it makes money and how it spends its cash. This difference directly flows down to how much the stock is worth. Operating in the application software industry, ALU is currently valued at AU$2.8b. Today we will examine ALU’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 Altium’s cash yield?
Altium’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 Altium to continue to grow, or at least, maintain its current operations.
There are two methods I will use to evaluate the quality of Altium’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, Altium also generates a positive free cash flow. However, the yield of 1.18% is not sufficient to compensate for the level of risk investors are taking on. This is because Altium’s yield is well-below the market yield, in addition to serving higher risk compared to the well-diversified market index.
What’s the cash flow outlook for Altium?
Can ALU improve its operating cash production in the future? Let’s take a quick look at the cash flow trend the company is expected to deliver over time. In the next couple of years, the company is expected to grow its cash from operations at a double-digit rate of 69%, ramping up from its current levels of US$48m to US$82m in three years’ time. Furthermore, breaking down growth into a year on year basis, ALU is able to increase its growth rate each year, from 12% in the upcoming year, to 19% by the end of the third year. The overall picture seems encouraging, should capital expenditure levels maintain at an appropriate level.
The company’s low yield relative to the market index means you are taking on more risk holding the single-stock Altium as opposed to the diversified market portfolio, and being compensated for less. Though the high operating cash flow growth in the future could change this. Now you know to keep cash flows in mind, I recommend you continue to research Altium to get a better picture of the company by looking at:
- Valuation: What is ALU 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 ALU 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 Altium’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.