There are many approaches to determine the value of an equity an investor is looking to purchase stake in. I have often found the most effective way to uncover value is through analyzing a company’s statement of cash flows along with analyzing their annual reports. Cash flows provide a more concrete look into a company’s performance and overall standing on a quarter over quarter and year over year basis in comparison to income statements. The other key component of finding value in a company is outside of financials. It’s being able to determine what they are doing keep up with industry trends, new consumer needs, and their success in satisfying their current niche. Investors value stocks based on a number of factors such as growth capabilities, market cap, industry lifecycle, and financials.
Cash is King
Nobody wants to buy a company without cash. How much cash a company can generate is an important measure of its health. Without cash, a company won’t last long. Two great measurements that can be used to shed light on a company’s valuation are Price to Cash Flow and Free Cash Flow. These ratios help investors determine if a company is over or under valued essentially the same way a Price to Earnings ratio would. Price to cash flow is a company’s net income with the depreciation and amortization charges added back in. These charges reduce net income but are not actual cash outlays thus cash reported is artificially reduced. Price to cash flow allows investors to get a feel for the company’s price based on the company’s actual cash. This ratio can be found by dividing the stock’s price by cash flow per share. This can give a less speculative glimpse into the company over computing earnings per share. The other measurement worth using is free cash flow. Free cash flow is found by dividing the current price by free cash flow per share. The quotient describes the market’s value based on the company’s cash generating abilities. Like profit to earnings, these ratios suggest the market’s valuation of the company. Low numbers relative to sector and industry will often suggest the stock is undervalued and there is a buying opportunity. Higher numbers offer warning signs of over valued stocks.
Company Efforts Compared Against Social Sentiment
Numbers tell half of the story for investors. The other half needs to be derived through reading, news, and other channels. Investors need to know what a company is doing and also planning to do to compete against others in their sector as well as keep ahead of industry shifts. Investors can get a finger in the wind on company actions through their annual reports. This report is probably the most official way to access a company’s goals, industry outlooks, and last year’s key performance indicators. Investors should always take a look into see how well a company completed its goals for the previous year as a starting point because efficiency paints an attractive picture for growth seeking investors. The other half of this portion of stock analysis is taking what a company says they are going to do and comparing that to social sentiment around the specific company or the sector. Take PayPal (NASDAQ: PYPL) for example. Millennials did not want to create PayPal accounts nor did they have a practical use for PayPal up until recent years when they launched Venmo. PayPal had made it a goal to capitalize on the smart phone generation and since traditional PayPal accounts were becoming stale, they brought Venmo into the picture. This app is probably on 80% of Millennial’s phones and it single handedly made PayPal cool again. Comparing PayPal’s goals of bringing Venmo to market against Twitter, news, and other social media outlets mentions of Venmo would tell a clear story that they have succeeded in outperforming in this changing market. This type of analysis of news against social sentiment against corporate releases is what investors need to take into account in order to tell the story of what a company is doing and how well they are doing it.
How These Two Analyses Can Paint A Picture
In closing, I will use the aforementioned analytical approaches to help paint a clearer picture about a stock. Since I have already started to use PayPal I will continue with using the stock as an example. Let’s start with the story. PayPal has had a rocking 2016 reaching near all time highs here in early 2017. Starting with the news, PayPal announced they were adding significant focus to the Venmo campaign in their 2015 annual report. After reading about the Venmo initiative we can infer that this is PayPal’s strategy for getting into the mobile payment processing space while also building the PayPal user base. Since this isn’t a full fledged analysis of PayPal, I am going to skip the granular analytical details and fast forward to sentiment and news. A few Google searches and you will find that over the course of 2016 Venmo has been embraced by Millennials just as PayPal intended. So what about the monetary success? Looking at the company’s price to cash flow of 24.46 we can see that the market has undervalued PayPal over the industry at 26.52. PayPal also closed 2016 with a free cash flow of $2.49 billion which, divided by shares outstanding results in a free cash flow ratio of 2.06. Since this number is greater than one, or in this case two, we know PayPal generates enough cash in an annual period than it needs to pay off short term liabilities. We can now conclude that Paypal is growing steadily and disrupting the mobile payment processing space. We can also conclude that companies like Visa and Mastercard along with ApplePay have not stunted PayPal’s growth. Overall we can now look at the company through a view that tells us that they not only are expanding, but are making good on their operating expenses and growing cash.
In short, cash flow analysis can be coupled with social sentiment and news analysis to paint a great company picture that is less subject to speculation. Adding the aforementioned methods of analysis to an already established repertoire may lend a new view for seasoned investors while also giving new investors a less subjective view into a company they may be willing to purchase.