Free cash flow to equity (FCFE) shows how much cash is left for the company’s equity shareholders after covering all costs, reinvestments, and debt obligations. It reflects how effectively equity capital is being utilized.
Learn more about Free Cash Flow to Equity
Free cash flow to equity includes net income, capital expenditures, working capital, and debt. You can find net income on the company’s income statement. Capital expenditures are listed in the investing section of the cash flow statement.
Working capital is also on the cash flow statement, but it’s in the operations section. Basically, working capital shows the difference between the company’s current assets and liabilities.
These are the short-term funds needed for day-to-day operations. Net borrowings are found in the financing section of the cash flow statement. Just a heads up, interest expense is already factored into net income, so there’s no need to add it back in.
Calculation of FCFE
FCFE = Cash from operations − Capex + Net debt issued
FCFE Tell You
The FCFE metric is a go-to for analysts trying to figure out a company’s value. It’s become a popular choice over the dividend discount model (DDM), especially for companies that don’t hand out dividends. While FCFE shows how much cash is available for shareholders, it doesn’t always mean that’s the amount they actually receive.
Analysts look at FCFE to see if dividends and stock buybacks are funded by free cash flow to equity or if they’re relying on other financing methods. Investors prefer to see that dividends and buybacks are fully covered by FCFE.
If FCFE falls short of what the company pays out in dividends and share repurchases, it means they’re likely using debt, existing capital, or issuing new securities to cover the difference. Existing capital refers to retained earnings from previous years.
This situation isn’t ideal for investors, even with low interest rates. Some analysts believe that borrowing to fund share buybacks can be smart if the shares are undervalued and interest rates are low, but this only works if the company’s stock price rises later on.
When a company’s funds for dividends are much lower than its FCFE, it usually means they’re saving the extra cash or investing in marketable securities. On the flip side, if the money spent on buybacks or dividends is roughly equal to the FCFE, it indicates that the firm is returning all that cash to its investors.
Conclusion
Free cash flow to equity shows the amount of cash left for a company’s equity shareholders after covering all costs, reinvestments, and debt obligations. It’s a way to gauge how effectively equity capital is being utilized.