Is Cash Trash 🗑️ or King 👑
To contextualize this conversation I'm talking about the cashflows that a business produces.
There are many businesses who are printing cash, and the market just doesn't care. Earnings growth is being prioritized over cashflow growth, but is this the right way to look at things?
Let's take PayPal for example, selling today at about $46.00 per share ($41.56bn). They just reported earnings growth of about 1%, obviously not flashy to anyone ... buuuuut, they reported adjusted FCF growth of 25%.
If you were to buy a share of PayPal today, you'd be entitled to about 5.45 EPS which puts this at a PE of 8.5(ish). With flat earnings growth, that price makes some sense. it would take 8.5 years to return a 100% based on earnings which coincidentally using the rule of 72 puts us at about an 8.5% annualized return. That's nothing exciting, especially when there are high flying AI names that will make that in a week (maybe).
So the market may be justified, but is it ignoring the cashflows?
PayPal is also making $6 in FCF per share which means we are trading at about 7.6 P/FCF which is a bit better, but then we have to remember they posted growth of 25%. A prudent question would be, "Is that sustainable?", well fcf has been growing at a CAGR of around 10%, so that might be a more prudent metric to use when formulating a valuation.
So a company, producing $6 in FCF growing at 10% per year in 10 years would be generating $15.50 in FCF per share. Using a 15% discount rate (we target a 15% ROR because the only reasont to take on equity risk over an index is to demand higher returns) that puts fair value at around $75 per share meaning we currently have about a 38% margin of safety.
We have margin expansion aswell on our side, as PayPal historical has traded around 15-20 times FCF.
To most people that would sound pretty good, so why is the market ignoring cashflows?
I used PayPal as an example, but there are numerous companies who fit this profile. High cashflow producing businesses who are being thrown out.
Is cashflow still king like Warren Buffett would suggest, or are future earnings at all cost then end all be all?
