If you are currently a shareholder in Persimmon Plc (LON:PSN), 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 PSN’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?
Persimmon 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.
I will be analysing Persimmon’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
Persimmon’s yield of 10.25% last year indicates its ability to produce cash well-above the market index, given the size of the company. This means investors are adequately rewarded for the risk they take on by overweighting Persimmon.
What’s the cash flow outlook for Persimmon?
Does PSN’s future look brighter in terms of its ability to generate higher operating cash flows? This can be estimated by examining the trend of the company’s operating cash flow moving forward. Over the next couple years, the company is expected to grow its cash from operations at a double-digit rate of 44%, ramping up from its current levels of UK£654m to UK£942m in three years’ time. Although this seems impressive, breaking down into year-on-year growth rates, PSN’s operating cash flow growth is expected to decline from a rate of 30% in the upcoming year, to -8.1% by the end of the third year. However the overall picture seems encouraging, should capital expenditure levels maintain at an appropriate level.
The outcome of Persimmon’s cash flow analysis is compelling. Its high potential lies in above-market cash yield as well as a strong cash flow growth outlook. 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 Persimmon to get a better picture of the company by looking at:
- Valuation: What is PSN 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 PSN 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 Persimmon’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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