Baidu vs. Google: A Free Cash Flow Analysis 22 comments
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I have analyzed Baidu (BIDU) and Google (GOOG) from a Free Cash Flow perspective to determine how those companies are doing on Main Street and let the numbers decide which is more attractive. My key ratios for analysis are Price to Free Cash flow (PFCF) and Free Cash Flow Return on Invested Capital (FROIC).
When investing I look for PFCF below 15 times and FROIC above 20%+. When you are lucky enough to find a combination of the two you find a perfect balance of growth + value and you get capital appreciation through capital preservation. Since both stocks do not meet the criteria of what I look for as an analyst, I am not investing in either. The following analysis is done purely to assist those who invest in the companies, so that they may get a better perspective of what is happening on Main Street.
Free Cash Flow Analysis cuts through the Hype and gets you to the real deal.
Always remember “the numbers don’t lie, only people do.”
For those who don't know:
PFCF = Market Price/ (Cash flow per share-Capital Spending per share)
FROIC = FCF per share/ (long term debt per share + shareholders equity per share)
FROIC basically tells you how much return in free cash flow a company generates for every dollar of Total Capital they employ.
I consider FROIC the primary determining factor in identifying great growth companies as you can compare every company (except financials) on an equal basis.
The question I ask every company I analyze is - how much return (in percent) in FCF are you going to give me for every dollar of total capital you invest?
First let’s analyze Baidu, as it was in the news Tuesday falling -11.55%.
The following are the Price to Free Cash Flow and Free Cash Flow Return on Invested Capital estimates for Baidu with data used in calculations courtesy of Thomson-Reuters;
Market price used in calculations = $383.66
Year 2009
Free Cash Flow Per Share = $2.86
Total Capital Per Share = $20.54
Price to Free Cash Flow = 134 times
Free Cash Flow Return on Invested Capital = 9.88%
Year 2010
Free Cash Flow Per Share = $4.78
Total Capital Per Share = $29.54
Price to Free Cash Flow = 80 times
Free Cash Flow Return on Invested Capital = 13.07%
Year 2011
Free Cash Flow Per Share = $7.70
Total Capital Per Share = $40.10
Price to Free Cash Flow = 50 times
Free Cash Flow Return on Invested Capital = 16.76%
And now let us move on to Google.
The following are the Price to Free Cash Flow and Free Cash Flow Return on Invested Capital estimates for Google with data used in calculations courtesy of Thomson-Reuters;
Market price used in calculations = $548.30
Year 2009
Free Cash Flow Per Share = $22.69
Total Capital Per Share = $112.44
Price to Free Cash Flow = 24 times
Free Cash Flow Return on Invested Capital = 20.17%
Year 2010
Free Cash Flow Per Share = $26.05
Total Capital Per Share = $139.61
Price to Free Cash Flow = 21 times
Free Cash Flow Return on Invested Capital = 18.65%
Year 2011
Free Cash Flow Per Share = $33.42
Total Capital Per Share = $175.02
Price to Free Cash Flow = 16 times
Free Cash Flow Return on Invested Capital = 19.09%
Now let us move on to the Growth rates of each company's free cash flow, generating one % number for growth from 2009-2011
Baidu = 169.23% expected growth of FCF from 2009 to 2011 (this is not annualized but compounded)
Google = 47.28% expected growth of FCF from 2009 to 2011 (this is not annualized but compounded)
There is your analysis, I have no opinion either way and will let each reader decide the level of risk that they are willing to take
As for my philosophy on investing I do the following:
FROIC gives me a real return on Main Street and if I can get a 20%+ return on Main Street and at the same time buy a stock that is selling for less than 15 times its FCF then there is a very high probability that it should be very successful investment.
By choosing 20%+ as my minimum FROIC I have built a portfolio of 29 holdings for my clients that has a combined portfolio FROIC of 32% and sells as a group for 12.35 PFCF.
As for PFCF I came up with the 15 or less number as being Ideal after performing a 58 year backtest. To view the backtest just click here (.pdf).
Disclosure: No Position BIDU, GOOG
The Fine Print: As Registered Investment Advisors, we see it as our responsibility to advise the following: We do not know your personal financial situation, so the information contained in this communiqué represents the opinions of Peter "Mycroft" Psaras, and should not be construed as personalized investment advice.
It should not be assumed that investing in any securities we are investing in will always be profitable. We take our research seriously, we do our best to get it right, and we “eat our own cooking,” but we could be wrong, hence our full disclosure as to whether we own or are buying the investments we write about.
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The FCF of course being Operating CF - Capex?
Goog 09'
MV = 177,005.5
FCF = 7,736
= 22.8 is that right?
I used these numbers off of Factset, do you normally use Yahoo Finance? I find their Dividend figures are constantly wrong, and that their other numbers can be old and out dated. I saw you had 24 down for Goog...
Are there any other good sites that give you the per share cash & Capital figures or do you just use the Balance Sheet, Income Statement & Cash Flow Statement?
I noticed ADM
MV = 19,331.7
FCF = 3,096
= 6.2
Also my oil driller NE
MV = 11,150.5
FCF = 878.8
= 12.6
Some defense, Health Care, and Cig stocks did well with the formula too?
On Oct 28 05:18 AM endoftheworld wrote:
> Did you include or exclude Stock Based compensation in your calculation
> of "Free Cash Flow"?
On Oct 28 05:23 AM Sartre wrote:
> Very interesting analysis. Can you post the top five stocks that
> meet your criteria?
The Google 2009 numbers are in the article.
ADM FCF per share =$2.25
ADM FROIC = 6%
NE FCF per share =$2.86
NE FROIC = 8.5%
Disclosure: No Position in ADM, NE
The Fine Print: As Registered Investment Advisors, we see it as our responsibility to advise the following: We do not know your personal financial situation, so the information contained in this communiqué represents the opinions of Peter "Mycroft" Psaras, and should not be construed as personalized investment advice.
It should not be assumed that investing in any securities we are investing in will always be profitable. We take our research seriously, we do our best to get it right, and we “eat our own cooking,” but we could be wrong, hence our full disclosure as to whether we own or are buying the investments we write about.
On Oct 28 09:13 AM John Galt wrote:
> Can you simply divide the MV by the FCF?
> The FCF of course being Operating CF - Capex?
>
> Goog 09'
> MV = 177,005.5
> FCF = 7,736
> = 22.8 is that right?
>
> I used these numbers off of Factset, do you normally use Yahoo Finance?
> I find their Dividend figures are constantly wrong, and that their
> other numbers can be old and out dated. I saw you had 24 down for
> Goog...
>
> Are there any other good sites that give you the per share cash &
> Capital figures or do you just use the Balance Sheet, Income Statement
> & Cash Flow Statement?
>
> I noticed ADM
> MV = 19,331.7
> FCF = 3,096
> = 6.2
>
> Also my oil driller NE
> MV = 11,150.5
> FCF = 878.8
> = 12.6
>
> Some defense, Health Care, and Cig stocks did well with the formula
> too?
On Oct 28 10:24 AM Albert Meyer wrote:
> Thanks... are you the same Mycroft who was active on the Coke Yahoo
> board in 1998?
ROIC is a useful ratio as long as it is always used together with Cost of Capital. Only when ROIC>WACC would the company be a potential good investment. Consider a company's ROIC is even larger than your criteria 20% say 30%. Is it a good investment? What if its cost of capital is 35%?
In addition, for me, numbers always lie. Companies have tons of ways to increase present year FCF. One example is that they reduce R&D to sacrifice future growth.
These above are only my humble opinion.
On Oct 28 10:37 AM Peter Mycroft Psaras wrote:
> Yes I am the same ;-)
With yesterday’s faulty price action, gaping open almost 1% from yesterday's close to 439, then rising a measly single dollar to 440 before collapsing 15 and splitting the difference to close at 433, or 55% of the daily range, Baidu (BIDU) appeared to have completed every necessary little squiggle within a long-term Elliott Wave pattern ahead of its earnings announcement. A single High Wave hourly candlestick pattern appears to have marked an historic peak for shares of BIDU at 11:00 am yesterday ....
Full article with fully annotated Elliott Wave charts at:
fibozachi.com/technici...
On Oct 28 10:42 AM Michael Xiao-Yong Xie wrote:
> Please forgive my straightforwardness. But if these are the only
> two criteria you used, the model was probably abused.
>
> ROIC is a useful ratio as long as it is always used together with
> Cost of Capital. Only when ROIC>WACC would the company be a potential
> good investment. Consider a company's ROIC is even larger than your
> criteria 20% say 30%. Is it a good investment? What if its cost of
> capital is 35%?
>
> In addition, for me, numbers always lie. Companies have tons of ways
> to increase present year FCF. One example is that they reduce R&D
> to sacrifice future growth.
>
> These above are only my humble opinion.
>
>
Of course those are mean and median estimates and the high estimates for Cash Flow are $7.06 for 2009 and $10.02 for 2010. In my business though I can't afford to use high estimates as that can get you in serious trouble if the company misses. So I would suggest using mean and median estimates in your work as the estimates you are using are obviously the high ones.
On Oct 29 03:51 AM Game wrote:
> My calculation suggests that Baidu's FCF per share in FY09 and FY10
> are US$6.2 and US$10.4, more than twice that of your numbers. Are
> u sure your FCF numbers are correct???
If you recognize that FCF should be the residual cash flow companies throw off after taking into account all spending required to run the company, thus FCF should be the cash available to the stock and bond holders, in your analysis, if you are using reported numbers, you are neglecting to account for the substantial amount of compensation employees would require, though in the form of stock.
This is a quirk that most analysts ignore for some reason. If a company pays a $10million to employees in stock, its ignored in the FCF, but if it pays $10m in salaries, its counted. Net impact is that employees walk away with $10m cash regardless. Where does the cash come from in the case of options/stock? Financed by existing shareholders. This can be extremely significant, especially in growth/tech companies. You should account for the fact that some of the operating cash flow should be reduced for this factor, which is the reason why stock comp amortization was principle behind their inclusion in GAAP figures.
by the way the Question was:
Did you include or exclude Stock Based compensation in your calculation of "Free Cash Flow"?
On Oct 28 09:49 AM Peter Mycroft Psaras wrote:
> I use diluted shares outstanding in my calculations so therefore
> everything gets included in that.
I do not include them in the cash flow side (numerator) but do included them in the (denominator) as everything is included in there.
"
Investopedia Says
Investopedia explains Fully Diluted Shares
An investor should consider carefully the fully diluted share amount because it can cause a company's share price to plummet significantly if a large number of option holders or convertible bond holders decide to claim their stock.
For example, let's say that XYZ Corp. currently has 1 million shares outstanding, 1 million options outstanding (assuming each option gives the right to buy one share) and its share price is $5. If everyone decides to exercised their options, there would be 2 million shares outstanding and the share price would likely drop to $2.50. "
The method I use has been very successful for me and my FCF, FROIC methods have done wonders for my results. I hope that explains my method and allows the non-professionals who are reading this to understand what we are doing. Diluted shares solves the problem of compensation and that is the only number I use in my calculations.
On Oct 29 08:56 AM endoftheworld wrote:
> The reason I'm asking is that most companies add back "stock based
> compensation" in their calculation of Operating Cash Flow (seekingalpha.com/symbo...).
> The typical analyst simply calculates reported OCF-Capex=FCF to calculate
> Free Cash Flow.
>
> If you recognize that FCF should be the residual cash flow companies
> throw off after taking into account all spending required to run
> the company, thus FCF should be the cash available to the stock and
> bond holders, in your analysis, if you are using reported numbers,
> you are neglecting to account for the substantial amount of compensation
> employees would require, though in the form of stock.
>
> This is a quirk that most analysts ignore for some reason. If a company
> pays a $10million to employees in stock, its ignored in the FCF,
> but if it pays $10m in salaries, its counted. Net impact is that
> employees walk away with $10m cash regardless. Where does the cash
> come from in the case of options/stock? Financed by existing shareholders.
> This can be extremely significant, especially in growth/tech companies.
> You should account for the fact that some of the operating cash flow
> should be reduced for this factor, which is the reason why stock
> comp amortization was principle behind their inclusion in GAAP figures.
>
>
> by the way the Question was:
>
> Did you include or exclude Stock Based compensation in your calculation
> of "Free Cash Flow"?
>
> On Oct 28 09:49 AM Peter Mycroft Psaras wrote:
If you ARE going to use Free Cash Flow to value stocks, you should use FCF. The Enterprise Value (EV) of the company is independent of the capital structure (other than the tax impact assuming its not distressed). It DOES depend on the FCF value you use though. You should use the (correct) lower FCF to calculate EV AND use the appropriate adjustments to calculate the dilution impact based on the fair value of the options. Most of these Items are included in the GAAP statements. You can use OCF-Stock Based Comp - Capex=FCF, and use GAAP diluted shares as a better estimate. The company's already done the math for you in most cases.
Most of the dilution adjustments depend on the current stockprice, exercisability and cash flows from the diluting instruments, so its not a simple linear relationship of doubling the shares for example in your example. What you DO end up doing is getting an inflated present value of EV when you use an inflated FCF for longterm projections, especially when you project them out and assume a growth rate. Its not as simple as dividing by "diluted" shares to get to the true value.
On Oct 29 09:33 AM Peter Mycroft Psaras wrote:
> www.investopedia.com/t...
>
> I do not include them in the cash flow side (numerator) but do included
> them in the (denominator) as everything is included in there. <br/>
>
> "
> Investopedia Says
> Investopedia explains Fully Diluted Shares
> An investor should consider carefully the fully diluted share amount
> because it can cause a company's share price to plummet significantly
> if a large number of option holders or convertible bond holders decide
> to claim their stock.
>
> For example, let's say that XYZ Corp. currently has 1 million shares
> outstanding, 1 million options outstanding (assuming each option
> gives the right to buy one share) and its share price is $5. If everyone
> decides to exercised their options, there would be 2 million shares
> outstanding and the share price would likely drop to $2.50. "
>
> The method I use has been very successful for me and my FCF, FROIC
> methods have done wonders for my results. I hope that explains my
> method and allows the non-professionals who are reading this to understand
> what we are doing. Diluted shares solves the problem of compensation
> and that is the only number I use in my calculations.
My number is actually close to the mean FCF of Bloomberg and ur number is much lower than Bloomberg mean for FY09 and FY10.
On Oct 29 06:06 AM Peter Mycroft Psaras wrote:
> I use Thomson Reuters and their Cash Flow per share estimate for
> 2009 is $5.41 and for 2010 is $7.84 , so my numbers are correct because
> the cash flow numbers alone are much lower then your numbers and
> I have not even taken out Cap Ex from them yet.
>
> Of course those are mean and median estimates and the high estimates
> for Cash Flow are $7.06 for 2009 and $10.02 for 2010. In my business
> though I can't afford to use high estimates as that can get you in
> serious trouble if the company misses. So I would suggest using mean
> and median estimates in your work as the estimates you are using
> are obviously the high ones.
On Oct 29 06:06 AM Peter Mycroft Psaras wrote:
> I use Thomson Reuters and their Cash Flow per share estimate for
> 2009 is $5.41 and for 2010 is $7.84 , so my numbers are correct because
> the cash flow numbers alone are much lower then your numbers and
> I have not even taken out Cap Ex from them yet.
>
> Of course those are mean and median estimates and the high estimates
> for Cash Flow are $7.06 for 2009 and $10.02 for 2010. In my business
> though I can't afford to use high estimates as that can get you in
> serious trouble if the company misses. So I would suggest using mean
> and median estimates in your work as the estimates you are using
> are obviously the high ones.
Current Numbers for Cash Flow
$7.439 = 2009
$10.39 = 2010
Capital Expenditures
$77.27 million = 2009
$93.15 million = 2010
Diluted Weighted Shares = 35 million
Cap ex per share
$2.207 = 2009
$2.66 = 2010
Updated Free Cash Flow Estimate
$5.23 = 2009
$7.73 = 2010
Thank you for allowing me to update the article. BIDU must have had some amazing results for there to be such a large jump in their numbers. Congratulations, if you own it.
In the end you are only as good as your data providers data.
Thanks again for the update.
On Oct 29 10:18 PM Game wrote:
> Thomson Reuters CFPS fro FY09 is 7.49(high-7.92, low-7.07); FY10
> is 10.24(high-10.45, low-10.02).
>
> On Oct 29 06:06 AM Peter Mycroft Psaras wrote:
Here’s the logic: when a company issues options IN LIEU OF CASH COMPENSATION and then buys back the stock issued as a consequence of the options program, it has merely paid cash compensation by means of a two-stage process. There are stock buybacks that shrink the pie (for example, if Berkshire were to repurchase stock) and stock buybacks that merely mop up dilution (for example, Cisco’s stock buybacks, for the most part)
Cisco’s employees contributed $15 billion through stock option exercises during the period under review. Hence, my calculation of free cash includes an adjustment that calculates the cost of repurchasing the stock issued to employees net of their contributions on exercise, to arrive at “unfettered free cash flow.”
By the way, the cost of mopping up (market value minus exercise price = discount at which stock issued to employees) is the very amount that companies claim as a tax deduction for stock-based compensation.
In summary: for a more reliable free cash flow number, adjust conventional free cash flow for the cost of mopping up stock option diluting.