The Georgia Tech Financial Analysis Lab conducts unbiased research on issues of financial reporting and analysis. Unbiased information is vital to effective investment decision-making. Accordingly, we think that independent research organizations, such as our own, have an important role to play in providing information to market participants.
Because our lab is housed within a university, all of our research reports have an educational quality, as they are designed to impart knowledge and understanding to those who read them. Our focus is on issues that we believe will be of interest to a large segment of stock market participants. Depending on the issue, we may focus our attention on individual companies, groups of companies, or on large segments of the market at large.
A recurring theme in our work is the identification of reporting practices that give investors a misleading signal, whether positive or negative, of corporate earning power. We define earning power as the ability to generate a sustainable stream of earnings that is backed by cash flow. Accordingly, our research may look into reporting practices that affect either earnings or cash flow, or both. At times our research may look at stock prices generally, though from a fundamental and not technical point of view.
The Free Cash Profile: Insight into the Cash Flow Implications of Growth
An Analysis Using 2014 Data
As the U.S. economy continues its slow recovery, companies are once again enjoying renewed, if limited, revenue growth. In terms of cash flow generation, as revenues grow, there are certain industries and companies that will benefit more than others. It is a common misbelief that growth requires a use of cash. The reality is that there are many companies that actually generate increasing amounts of free cash flow as revenues grow. These companies have what we refer to here as a positive free cash profile.
The purpose of this study is to analyze the free cash profile of 44 non-financial industries, looking at all firms within those industries that have revenues in excess of $100 million. Our goal is to identify those industries that can be expected to generate cash as revenues continue to grow, as well as those industries that will consume cash with growth. We also highlight specific industries to investigate factors underlying their free cash profile.
Overall, the median free cash profile for our sample is 2.22%, below the median profile of 3.35% observed in 2013. A decline in operating cushion, an increase in working capital needs and an increase in capital expenditures all contributed to the drop in free cash profile. There are 20 industries with a positive free cash profile, and 24 industries with a negative free cash profile—though even in these industries, there will be numerous firms with positive profiles. Industries with positive free cash profiles enjoy higher operating cushions and are more adept at managing operating working capital and limiting capital spending than industries with negative profiles.
Data for this research were provided by Cash Flow Analytics, LLC., www.cashflowanalytics.com.
Charles Mulford is a principal in Cash Flow Analytics, LLC.
Earnings Quality: Reports on Individual Companies and Industries
In these reports we examine one or more dimensions of earnings quality: the cash flow support of earnings, the sustainability of earnings, or the quality of the balance sheet.