Why Free Cash Flow Matters

Why Free Cash Flow Matters August 12, 2005

As great as it is to find a company with strong free cash flow, the metric itself really only lets you peer into the operational profitability of a business. What a company does with its free cash flow is just as important as having it in the first place. Companies that simply hoard their cash or spend it aimlessly on acquisitions will likely do more harm than good to your portfolio.  

As an investor, you’re much better served to look for companies that take their free cash flow and put it toward share repurchases when their shares are below their intrinsic value or, better yet, toward a regular cash dividend. The beauty of being an income investor and receiving a cash dividend is not only that you get a guaranteed tangible return, but that you also have the option to reinvest the money received in more shares of the same business or another opportunity. The point is that you get to decide how the cash is allocated.

Just make sure that the company is like ExxonMobil (NYSE: XOM), which pays out a portion of its free cash flow as a dividend, and not like ConAgra (NYSE: CAG), which pays out more in dividends than it generates in free cash flow.


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