Amdocs Limited (NASDAQ:DOX) 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. 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 DOX’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?
Amdocs 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 Amdocs’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
Along with a positive operating cash flow, Amdocs also generates a positive free cash flow. However, the yield of 3.88% is not sufficient to compensate for the level of risk investors are taking on. This is because Amdocs’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 Amdocs?
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 DOX’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 25%, ramping up from its current levels of US$557m to US$698m in two years’ time. Although this seems impressive, breaking down into year-on-year growth rates, DOX’s operating cash flow growth is expected to decline from a rate of 13% next year, to 10% in the following year. But the overall future outlook seems buoyant if DOX can maintain its levels of capital expenditure as well.
Although its positive operating cash flow, and high future growth, is appealing, the low free cash flow yield is unattractive. 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 suggest you continue to research Amdocs to get a better picture of the company by looking at:
- Valuation: What is DOX 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 DOX 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 Amdocs’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.