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DCC plc (LON:DCC) 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 DCC’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?
Free cash flow (FCF) is the amount of cash DCC 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.
I will be analysing DCC’s FCF by looking at its FCF yield and its operating cash flow growth. The yield will tell us whether the stock is generating enough cash to compensate for the risk investors take on by holding a single stock, which I will compare to the market index. The growth will proxy for sustainability levels of this cash generation.
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
DCC’s yield of 3.08% 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 DCC but are not being adequately rewarded for doing so.
Does DCC 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 DCC’s expected operating cash flows. Over the next couple years, the company is expected to grow its cash from operations at a double-digit rate of 39%, ramping up from its current levels of UK£427m to UK£591m in three years’ time. Although this seems impressive, breaking down into year-on-year growth rates, DCC's operating cash flow growth is expected to decline from a rate of 20% in the upcoming year, to 7.1% by the end of the third year. However 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, DCC 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. Now you know to keep cash flows in mind, I recommend you continue to research DCC to get a more holistic view of the company by looking at:
- Valuation: What is DCC 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 DCC 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 DCC’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.
We aim to bring you long-term focused research analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material.
If you spot an error that warrants correction, please contact the editor at email@example.com. 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.