Tuesday, October 6, 2009

Latest Amazon.com Reader Review

4.0 out of 5 stars Cash is king, September 20, 2009
By graham - See all my reviews

Bruce Berkowitz sums it up best on the cover, follow the cash and you can value the business. I found the book excellent in leading you through the balance and income statements and most importantly deciphering just how much cash is being generated. The free cash flow talked about in the book seems to approximate Buffet's "owners earning" but it helps in dealing with the tricky aspect of adjusting those earnings to deal with the full business cycle. The book references excel sample sheets throughout and details the methodology behind them in a clear and concise manner, this is not to say it is easy, sometimes you really have to think, but the answers are there. Thoroughly enjoyed the book and have made several very successful investments using it as part of my toolset to value a business. Highly recommended

Friday, September 18, 2009

Free Cash Flow and Deflation

In writing about Free Cash Flow and deflation, I am not predicting the US is about to enter a severe deflationary period. I am only suggesting a full-blown encounter with deflation is possible and that because it is possible, and especially because we are not accustomed to investing in a deflationary period, it is worthwhile to consider how we might use Free Cash Flow and Investor Return in a long-term deflationary scenario.

1) Why bother with deflation at all? First, the strong rebound from the March lows indicate the equity markets have essentially recovered and, if there are any major worries on the horizon, inflation – not deflation – is at the top of the worry list. Second, should in fact we find ourselves in a deflationary economy, there will not be much point in investing in stocks as both earnings and multiples have historically contracted in deflationary periods.

In my view, the post-March equity rebound has been primarily driven by 1) recognition the financial markets are not going to explode; 2) wishful thinking about the shape and magnitude of the recovery in the basic economy; 3) fear on the part of professional investors who, having produced negative returns for their clients over the past year, know they will be quickly abandoned by their clients should they miss an equity rebound and therefore are fully invested in equities; and 4) speculative trading in financial stocks that has infected non-financial sectors. While there is some evidence the economy is on the mend, there is also evidence to the contrary. Interpretation of economic data in this environment is very risky – there appears to be a lot of statistical “dust” overhanging the raw data and this is likely to persist until the economy – the economy – not the financial markets – return to some state of normalcy.
To the second point, even if the economy as a whole enters a strong deflationary period, it does not mean all companies will be equally affected. The equity market as a whole will suffer multiple contraction but some stocks will still provide attractive returns. The trick is identifying those industries and companies that will prosper in spite of general economic conditions.

2) How will use of the Free Cash Flow Statement and the Free Cash Flow Worksheet differ under strong deflation conditions as compared to more normal conditions?

Let’s first go through the Free Cash Flow Statement.


As long as most public companies continue to report declining or flat Revenues we know we are entering or are in a deflationary period. Thus far many firms have been able to “improve” reported earnings as compared to recent guidance – not compared to previous guidance or to period over period. On the one hand, the equity market has applauded the earnings “improvement”, attributing it to brutal cost cutting. On the other hand, the equity market has expressed confidence that Revenue increases will follow in subsequent quarters. The equity market wants it both ways but cannot have it both ways - because one company’s successful cost reductions are the lost Revenues of its vendors. The cost cutting (and therefore the Revenue declines) will continue until business capacity is aligned with consumer, business and government demand. The government can only spend so much before the financial markets rein it in (as the bond market in 1980, by not buying US Treasuries, forced President Carter to slam on the credit brakes – a different economic scenario than today’s but the bottom line is:eventually markets rule over governments – even governments run by geniuses). The consumer is not returning to the “borrow and spend beyond your means” lifestyle that resulted in the capacity/hiring increases by business that characterized the last ten years. As business continues to cut costs by eliminating jobs and reducing purchases, consumers will continue to prepare for worse days ahead by increasing saving and living within their means. Only when we see continued increases in Revenues across a large portion of the economy can we be confident that deflation is no longer a major problem. Until that occurs, ignore the data dust and the equity market’s wishful thinking.

Operating Cash Flow Margin (OCFM)

Because the OCFM excludes Depreciation and other accounting estimates that smooth cash flows into averages and long term estimates, the OCFM is a more real-time portrait of a company’s cost margin than any margin based on GAAP numbers – as is or adjusted. In times like this, big changes are happening fast in how companies allocate cash so the more sensitive a ratio is the better. There is no overall cost margin as sensitive as the OCFM. If you find one, please advise and we will post it on the website.
When the economy is expanding and companies are enjoying increasing Revenues, identifying the low cost producer in an industry or niche is sometimes less important than finding the company about to significantly expand market share with new products or services. But in a deflationary environment, the low cost producers have the advantage because price gets a lot more relative attention from purchasing managers than it does in good times. The OCFM will help you identify the low cost producers. But make sure you are sufficiently conservative when projecting the OCFM. If Revenues are projected to decline and a company has already made substantial cost cuts, the OCFM is unlikely to increase or stabilize.

∆ Working Capital

Always a headache, in good times and bad, ∆ Working Capital is difficult to interpret and harder to project. A decline in Revenues may reduce Working Capital, thereby increasing estimated Free Cash Flow per share. But a decline in Working Capital is not a sustainable long term source of Free Cash Flow and investor return, so be careful. Many companies have reduced Working Capital in 2009 – but they cannot effect material reductions forever. Watch Days Receivable. Large increases may suggest ramping Revenues by extending terms and/or deteriorating financial condition of customers. The longer your time horizon, the more you may want to consider adjusting the ∆ Working Capital estimate to a smaller number.


Many companies have reduced Capex given lower Revenues and prevailing uncertainties. These Capex reductions are obvious in the Free Cash Flow Statement but will not be fully reflected in GAAP earnings because of depreciation. Again, the Free Cash Flow Statement provides a faster take on what is actually happening in a company (and in the economy). In a deflationary period some companies will shift to almost entirely maintenance Capex. When high cost producers cut maintenance Capex, start the timer.
Again, one company’s Capex reduction translates into many other companies’ lost Revenues and lower Free Cash Flows. Monitoring a list of a company’s largest customers is even more important in a deflationary scenario. If the major customers are experiencing declining Revenues, and if your company’s Revenues are the major customers’ Capex, then your company may have a problem.

Free Cash Flow

The Free Cash Flow Margin (FCFM) is especially important in deflation periods. The equity investor must be more attentive than usual to a company’s ability to generate sufficient cash flow to continue operations, service debt and pay dividends, if any. GAAP EPS is not only of no help on these points – it can provide misleading information.

Free Cash Flow Deployment

The equity investor must understand how much potential a company is likely to have to do acquisitions, buyback stock and reduce debt. Yes, there are far fewer companies engaged in these deployments than was the case only several years ago! But many companies continue to deploy cash in ways that increase investor return.
It does seem likely that if deflation takes hold, the relative sources of investor return will change. In the past, Revenue increases accounted for a large share of investor return. In a deflationary scenario, Revenue increases will take on proportionally less importance than in recent years. The OCFM will be somewhat more important as the low cost producers exploit their advantages and are rewarded more than has usually been the case. But costs can only be cut so far. How then, will companies differentiate themselves from their competitors – if not by higher Revenue increases and bigger cost reductions? There is only one area left for management to increase investor return (if they care to!): superior capital management. The Free Cash Flow Worksheet provides a picture of how management is allocating capital, both internally generated capital (Free Cash Flow) and externally obtained capital (debt and equity issues). Those management teams that can optimize capital generation and deployment for the benefit of shareholders will separate themselves from those managers entirely focused on revenues and costs. And once deflation ends and inflation begins, these capital-savvy CEO’s and CFO’s should be able to deliver very good returns to their investors.

Where should we look for companies that will do relatively well in a deflationary period?

1) Corporate America’s unused capacity (created by American consumers spending beyond their means with borrowed cash) must be realigned with the newly frugal American consumer. So any company that derives a large segment of its Revenues from capacity-increasing products/services should be avoided for now.

2) Companies that sell high-priced consumer goods/services should be avoided and companies that sell low-priced consumer goods/services should be considered.

3) US companies whose Revenues have a high percentage of foreign sales should be considered.

4) Companies that sell products/services that address their customers’ critical needs that must be satisfied even while customers’ Revenues and/or cash flows are declining. An example in both the corporate and consumer market could be Internet security products.

5) Go through the 100 Companies Worksheet. Thinking about the industry’s products/services and looking at the Free Cash Flow Worksheet, which industries are likely to be the best performers in an extended deflationary period? Which companies are likely to be the low cost producers? Which management teams are likely to do the best job of managing capital? Which companies are likely to be in the best position to exploit a recovery?

Tuesday, September 1, 2009

An Article In Seeking Alpha about My NYSSA Presentation

Here is the link to the article on the Seeking Alpha site:


Tuesday, August 25, 2009

Latest Amazon.com Reader Review

2.0 out of 5 stars Oversimplification creates problems, August 21, 2009
By R. Reece (Orinda, CA United States) - See all my reviews
The author's definition of operating cash flow (from which he derives a profit margin that is important in his selection process) has a major flaw. In excluding all working capital changes from operating cash flow, his model misevaluates companies that are forced to make large accruals for deferred revenue. Any company that recognizes revenue ratably (over the term of a contract) falls in this category. Changes in deferred revenue accruals flow back into cash flow in the working capital line. This is one of the most important adjustments one must make to understand the earnings of companies with ratable revenue recognition.

The simplistic analysis of capital expenditures also causes many problems that lead one to cast out too many good stocks. Take for example WMS, a maker of slot machines. By the author's method, free cash flow is down 24% year over year. Why is the stock up about 40% over that span? A large chunk of WMS's capex is the cost of machines that are leased by casinos rather than purchased. WMS gets more than $60 a day in revenue from each machine, on average.

How does one evaluate the ROI? A machine might cost WMS $5,000-$8,000 to make. A casino needs to keep the machine on its floor little more than three months for WMS to get paid back for its investment. And when the casino returns the game to WMS, the company can refurbish it cheaply and re-lease it, or sell it outright.

WMS has grown gross cash flow (the author's version of operating cash flow) for four straight years, 26% CAGR, 250% increase. Over that span the stock little more than doubled. Perhaps it's still inexpensive now, or maybe it was overvalued four years ago.

WMS will never be inexpensive on free cash flow until the company ceases growing leased machine placements, which of course would be a bad thing. In such a case the author's method works in reverse, missing the growth story and finding a high ROI company only when its best days are behind it.

Thursday, July 9, 2009

New York City - August 20

I have been invited to speak at the New York Society of Security Analysts. The event starts at 5:30 pm on Thursday, August 20. Here is a link for location, registration fees, etc.:


Thursday, May 28, 2009

First Newspaper Review

Asheville Citizen-Times.com

May 24, 2009

Looking for good stock investments? Watch cash flow

David Coffee WCU Book Review

‘Free Cash Flow” is a book about the art of using cash-flow analysis to determine the fundamental value of companies and identify good stock investments.

The book is not appropriate as an introduction to equity investing. It is written for experienced investors with a basic understanding of the concepts embedded in accrual accounting and the conflicting relationship net income measurements based on generally accepted accounting principles, or GAAP, can have with cash flows.

While the focus of the book is narrow, the author offers a surprising number of key insights that can be useful to anyone investing in the stock market.

These insights may very well make this book worth reading, even if you lack a technical financial and accounting background.

While the typical “how to invest” books are written by professional investors or academics in finance, the author, George C. Christy, is neither. Christy, most recently the treasurer of a public company, was for 30 years a corporate banker in Chicago, Tokyo and Los Angeles. His perspective is based on his banking experience.

Because bank loans are “repaid by cash flow, not GAAP earnings,” the author learned early on how to analyze cash flow. After his banking work, he was a consultant at one of the country's largest investor relations firms, writing clients' earnings press releases, annual reports and corporate profiles, and helping CEOs and CFOs prepare for quarterly earnings conference calls and presentations.

Christy's career has given him an insider's perspective of how CEOs and CFOs manage public disclosures and relations with the street.

This book is an insider's perspective on cash-flow investing, which is very different from that of the typical money manager.

Christy characterizes accrual accounting as “the accounting fog machine,” and is critical of the complex array of estimates and assumptions required to generate periodic earnings measurements. He makes a case for using cash flows as a better measure of economic performance.

The importance of cash flows to valuation models is not new, as most valuation models project future cash flows and discount them back to their present value.

The concept of measuring “free cash flows” and using this metric as a basis of economic performance is, as the author points out, widely recognized in the financial community.

Unfortunately, there are several different definitions of free cash flow. Charles Schwab's Schwab Equity Ratings system defines free cash flow as accrual net income plus depreciation and minus capital expenditures and dividends.

Others define it as simply cash flows from operations or cash flows from operations less capital expenditures.

Christy's definition is essentially the latter. But the really important contribution of his book is not his particular definition of free cash flows, but his observations and insight into the importance of how the free cash flows are disposed of and how this disposal affects firm valuation and investor returns.

Christy considers all corporate strategies as falling into one of five possible disposals of free cash flows: cash dividends, share repurchases, debt pay-downs, new capital projects and acquisitions.

It is the disposal of the cash just as much as the generation of the cash that signals good stocks and bad stocks. This point is the key contribution of this book. It certainly made me think about issues I have been overlooking in my own valuation models and portfolio selections.

For example, suppose a company is using cash flow for acquisitions. Christy contends that acquisitions made outside the buyer's core business signal that management thinks its core business offers less than acceptable prospects.

Or suppose a company deploys free cash flows by making share repurchases. The book discusses six types of stock buybacks, one of which is referred to as “delusional buybacks.” These are done by companies with negative cash flows and result in investors owning a larger share of a company's negative cash flow.

Does this spark your interest? Read the book to learn about “nonbuybacks, bonus buybacks, defensive buybacks, front door buybacks and investor buybacks.” Only investor buybacks are good for valuation.

You may visit the author's Web site at www.OakdaleAdvisors.com. If you are a serious equity investor with an analytic perspective, you may find the book to be a refreshing approach to stock selection.

David Coffee is a professor of accounting in the College of Business at Western Carolina University. For previously reviewed books, visit www.wcu.edu/cob.
Additional Facts
About the book

Title: “Free Cash Flow: Seeing Through the Accounting Fog Machine to Find Great Stocks.” Author: George C. Christy. Publisher: John Wiley & Sons Inc. Length: 181 pages. Price: $49.95. Reading time: 10 hours. Reading rating: 6 (1 = very difficult; 10 = very easy). Overall rating: 3 (1 = average; 4 = outstanding).

Friday, May 15, 2009

First Reviews of Book

Below are the first reviews on the book I have seen. They are on the book’s page on Amazon.com. If you see other reviews, please do not assume I have seen them. Please email them to me so I can post them on the Forum.
Thanks for your help,

4.0 out of 5 stars Easy to understand cash flow analysis., May 15, 2009
By Ratatosk (Europe) - See all my reviews
This book is about cash flow analysis with emphasis on how much excess cash is generated by a company, also know as the Free Cash Flow, and which may deviate significantly from the reported Net Income hence revealing that a company is either more or less profitable than its Net Income suggests. For the most part the book is well written and easy to read.

The book was written by a former banker who focused on whether a company generated enough cash to repay its debt. I like that angle and combined with the book's simple language it is the best book for analysing cash flows that I am aware of. The book could however be improved in a few places which is why I haven't given it 5 stars. In particular I would have liked a deeper explanation and discussion of why the author has chosen that particular definition of Free Cash Flow as opposed to other definitions, e.g. why working capital changes are included. I would also have liked a deeper discussion on how to treat debt in the analysis, whether to deduct it or whether one should assume the same debt level could be sustained for eternity.

The book also includes Excel spreadsheets for calculating Free Cash Flow and these are made available for download on the internet. The book gives a long and detailed description on how to complete and interpret these spreadsheets. You will probably skip most of this description on a first reading and only use it for later reference, but it is very good to have when learning to use the techniques for computing Free Cash Flow, and more books in finance should have such detailed descriptions of their methods.

The book is recommended for people already experienced in analysing financial statements. While determined novices may also use this book for learning these things, I do recommend starting out with getting a proper understanding of financial statements first, for example by starting with the book Financial Statements by Thomas Ittelson.
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3.0 out of 5 stars Great investment advice but presented poorly, May 14, 2009
By Queen_Anne_Drizzle (Seattle, WA) - See all my reviews
I agree with most of what Christy writes. Free cash flow is the most important financial metric to follow. Christy points out that free cash flow is important but the smart investor also follows where the money is going. For example, you have to look at dividends, share buybacks, acquisitions and debt. Furthermore, his advice about examining annual reports to evaluate the tone of the CEO, her priorities and executive compensation are all very sound advice.

My problem with the book was its presentation. There is a long chapter in the middle of this fairly short book which ties it to his website. I found it hard to follow and tedious. A book should be stand alone and I did not like being directed to his Excel spreadsheets on his website. Teaching you how to design your own spreadsheets is fine but I did not think that the author did a good job teaching you how to do this through his book. Overall, great wisdom but needs improvement with writing and presentation.
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Share your thoughts with other customers: Create your own review


Reader Steve Ching emailed me about an error in Row 53 of the downloadable Free Cash Flow Worksheet on Wiley’s website. Row 53 is supposed to have the year column headings for the Percentages section of the Worksheet, but Row 53 takes the years that you input in Row 2 and spits them out as % numbers! I have given Wiley a corrected Worksheet. Thank you Steve!

Reader Tugrul Avci emailed me about the following errors:

- On page 10, paragraph 2, line 2, the number should be $1 million, not $10 million.

- The footnote number “1” on page 71, line 4, for the reference to the book Creative Cash Flow Reporting is not in the Notes section. Please refer to page 169 in the Recommended Reading section for details on the book.

- On page 83, Exhibit 6.18, cell A134, the correct spelling of “operations” is not “operaions”.

- The number in cell B125 in Exhibit 6.24 on page 91 should be the number that is in the same cell in the Six Restaurants Worksheet: $3,534.8, not $3,552.5

- On page 107, paragraph 2, line 3, “213%” should be “21.3%”.

Thank you Tugrul!

Here are several errors I have found:

- On page 46, in the paragraph directly above “CAPEX: MAGNITUDE AND

RISK”, line 1, the word “obtain” should be between the words “to” and “a

detailed breakdown”.

- On page 148, the “Step 3” title should read “Input Historical Statements into the

Free Cash Flow Worksheet”.

I apologize for these errors and hope they have not caused you difficulty. If you encounter other errors, please email me at gchristy@oakdaleadvisors.com so I can post them on the Forum.

Thank you,


Monday, April 20, 2009

No Fog Coffee - Paris

The second No Fog Coffee will be at Starbucks, 13 Rue des Archives on Saturday, May 2 from 3 PM
to 4 PM. I will have the book on the table so you'll know it's moi.
A bientot!

Friday, April 17, 2009

How to Start a New Topic

Unlike the previous Forum, I see all Comments before they are posted (in order to prevent spam and worse). On Blogger.com readers can comment on my posts but cannot make posts on new topics. If you would like to post a new topic, make a "Comment" on any of my posts and put “NEW TOPIC” at the beginning of your Comment. I will initiate the new topic for you with the text of your post and your name.

If you have any questions, please email me at gchristy@oakdaleadvisors.com

Thank you.

Thursday, April 16, 2009

100 Companies FCF Worksheet Updated

The 100 Companies FCF Worksheet has been updated with 2008 numbers. Some 9 companies were dropped (due to merger or major restatements)
and 10 companies were added. New companies are Adobe, Amazon.com, Alcon, Darden Restaurants, H.J. Heinz, Jack in the Box, Quality Systems, Raytheon,
Sanofi Aventis and Steak n Shake.
When I added 2008 numbers of companies already in the worksheet, I did not change previous years' numbers to reflect restatements by the companies.

Current Projects

I am working on two projects related to this book:

(1) Adding 2008 historical numbers to the 100 Companies Free Cash Flow Worksheet. This will take some time as I don't want to use the quarterly press releases'
unaudited numbers.

(2) Adding new "modules" to the Free Cash Flow Worksheet that capture, in the form of a checklist and equations, some of the material in Chapter 7 (Six Companies)
and Chapter 8 (CEO and Investor Return). I haven't decided how to disseminate them.

If you have any comments on the above, on the book or on what you'd like to see in the Forum, please either post them here or send me an email (please advise whether or not I
may summarize your comments and post them myself, with or without attribution).

No Fog Coffee - Manhattan - March 4

Please come to the first No Fog Coffee at 11 am on Wednesday, March 4. 2009 at Starbucks, 340 Madison Avenue (44th Street).
I will arrive before 11 to secure a table. A copy of the book will be on the table.
I have rimless glasses and will be wearing an orange + black striped tie and a blue + white striped shirt.
I have been told I look like a blend of Christopher Guest and Jiminy Glick.
Looking forward to meeting you!

Purchases / Maturities of Marketable Securities

A reader has asked why the Free Cash Flow Worksheet does not include purchases/maturities of marketable securities.
This is my reply:

Many companies have purchase/receipt of short term investments.

The FCF Worksheet ignores them. Think of the cash and marketable securities accounts as one account. Changes in the balance of the sum usually do not materially affect investor return.

The FCF Worksheet does not incorporate everything that is in the financial statements. It focuses on the most important events that affect investor return. But don't hesitate to make any modifications if you prefer a different approach.

You could put the net of the purchases/receipts in the Cash Sources section (if the purchases exceed the receipts you would use a minus sign). I don't do that for the same reason I do not put changes in the cash account in the Cash Sources section: I am more concerned with flows into and out of the company that directly affect investor return and I don't want changes in the cash+marketable securities accounts to muddy the waters. You could also argue that including the changes in cash+marketable securities is double-counting in that the changes are already reflected in the net changes of the other accounts.

I hope this is helpful. In the end you have to do it the way you're most comfortable with.

Adding Historical Periods to the FCF Worksheet

Please replace the directions (on page 100) for adding historical periods to the Free Cash Flow Worksheet with the following:

1) Insert new column between the existing column on the farthest right and the column to its left.
2) Paste Column C or I from the downloaded Free Cash Flow Worksheet into the blank column.
3) Change the years in Row 2 to the appropriate years.
4) Copy the formulas in Rows 49, 54-60, 73-74, 77-80, 110 and 132-134 FROM the newly pasted column and paste them INTO the existing column that is directly to the left of the
newly pasted column.

Call Transcripts on Seeking Alpha

On page 85 in the Projecting Free Cash Flow section of Chapter 6, the paragraph dealing with Row 37 refers to www.SeekingAlpha.com as a source of Capex guidance. Here is the link for the Transcripts Center:


After you enter a company’s stock symbol in the box and then choose the transcript you want from a list of transcripts, you will arrive at the transcript.
Look for “Single Page View” right below the words “Call Transcript” in the title at the top of the page. You are now in Single Page View mode – once you have finished reading page 1 you have to click on “Next Page” to go to page 2. By clicking on Single Page View you will change to Multiple Page View where you can move through all the transcript’s pages without clicking.
If you are looking only for management guidance on Capex and/or share repurchases, it is much easier to be in Multiple Page View. Companies that provide guidance often do so in the CFO’s commentary which usually follows the CEO’s opening statement. If the company provides guidance but it is not in the CEO’s or CFO’s opening statements, look in the Q&A. Often analysts will ask for guidance on these and other items. If there is no guidance on Capex or share repurchases, make sure it’s not in the quarterly earnings press release or in a press release/call focused on guidance. If there is no Capex data in any of the guidance provided by the company, what does that tell you?

Declining Revenue Projections

When you do 2009/2010 projections with the Free Cash Flow Worksheet, many of your companies’ Revenue estimates will either show declines from 2008 or reflect much lower growth rates because of the current economic troubles. Please consider the following:

1) Make sure your OCFM projection is realistic. If Revenues are projected to decline, there’s a good chance the OCFM will also decrease.
2) Look closely at the projected ∆ Working Capital number(s). A decline in Revenues may reduce Working Capital, thereby increasing estimated Free Cash Flow per share. But a decline in Working Capital is not a sustainable long term source of investor return, so be careful. The longer your time horizon, the more you may want to consider adjusting the ∆ Working Capital estimate to a smaller negative number.
3) Same for projected declines in Capex. Many companies are cutting back on
Capex given lower consumer spending and prevailing uncertainties. Sooner or later Capex of most of these companies should return to previous levels.

In sum, a swing in the ∆ Working Capital number from a positive number to a projected negative number and a projected decline in Capex may combine to produce a higher than realistic estimated Free Cash Flow per share number.