A recent article appeared in Forbes magazine that focused on the importance of cash flow versus earnings per share. The article, Investing Via Cash Flow, highlighted the success of Martin Saas, chairman of MD Saas. In the Forbes article, Saas notes, "investors get too fixated on the reported earnings...I am religious about cash flow. To me it's the most important number." Saas believes investors should start their review of the financial statement with the "cash flow from operations" statement.
This essentially consists of net income with noncash charges (like depreciation and deferred taxes) added back and cash-draining events (like an inventory pile-up) taken out. Now subtract maintenance-level capital expenditures. The company will tell you its total cap-ex; divining how that divides between maintenance and expansion is a tricky business, but you can strip out discretionary expenditures such as when oil companies increase drilling activity. What you're left with is free cash flow.
Investing Via Cash Flow
By: Daniel Fisher
March 25, 2010