dilettantedude

Cash Flows, Earnings Quality, & Stock Returns

first of all, anyone who values a stock based on quarterly, instead of estimated annual, FCF is an idiot. accruals vary greatly from quarter to quarter, and more so in seasonal companies. quarterly numbers contain a great deal of noise and little information, other than maybe being positive.

the FCF methodology makes sense from another viewpoint, also. wall street, and most other analysts, focus on EPS. because they do, that's what public companies manage. wall street does not focus on FCF, so it's a fairer representation of the true profitability of a company. all you have to do to see this is to graph FCF and EPS over several years. you can lay a ruler along the EPS bars, while the FCF bars jump all over the place.

nevertheless, a company with FCF/share consistently higher than EPS is almost by definiton being undervalued. it doesn't necessarily mean it's cheap, but clearly if real money/share is greater than manipulated EPS, and real money thus gets a lower multiple than "wall street money," something's wrong somewhere.