Table of Contents
- What Is Free Cash Flow to Equity (FCFE)?
- Key Takeaways on FCFE
- Components of Free Cash Flow to Equity (FCFE)
- Formula for Free Cash Flow to Equity (FCFE)
- Using Free Cash Flow to Equity (FCFE)
- Example of How to Use FCFE
- What Is Free Cash Flow to Equity (FCFE) Made Of?
- What Is the Formula for FCFE?
- Who Uses FCFE?
- The Bottom Line
What Is Free Cash Flow to Equity (FCFE)?
Let me explain what free cash flow to equity, or FCFE, really is. It's the cash a company has left to give to its shareholders after paying for all expenses, reinvestments, and debts. This metric tells you a lot about a company's financial health, and it's especially useful for companies that don't pay dividends. As an investor, you can use FCFE to check if things like dividends or stock buybacks are actually backed by the company's own cash flow.
Key Takeaways on FCFE
FCFE is simply the cash that's available to equity shareholders once you've accounted for all expenses, reinvestments, and debt repayments. You can think of it as an alternative to the dividend discount model when you're evaluating a company's financial health, particularly if the company doesn't pay dividends. The formula for FCFE starts with cash from operations, subtracts capital expenditures, and adds net debt issued. I always tell investors to look for dividends and stock buybacks that are funded by FCFE, because that means they're supported by real cash flow. If there's excess FCFE not used for those, the company might reinvest it or save it, which can be part of smart financial planning.
Components of Free Cash Flow to Equity (FCFE)
When you're breaking down FCFE, it includes net income, capital expenditures, working capital, and debt. You'll find net income right on the company's income statement. Capital expenditures are in the investing section of the cash flow statement. Working capital, which is the difference between current assets and liabilities, shows up in the operations section of the cash flow statement—it's basically the short-term capital for day-to-day operations. Net borrowings are in the financing section. Remember, interest expense is already in net income, so you don't need to add it back.
Formula for Free Cash Flow to Equity (FCFE)
Here's the straightforward formula for FCFE: FCFE equals cash from operations minus capex plus net debt issued. That's it—direct and to the point for your calculations.
Using Free Cash Flow to Equity (FCFE)
Analysts like me often turn to FCFE to figure out a company's value. It's a solid alternative to the dividend discount model, especially for companies that aren't paying dividends. FCFE shows you the cash that's available for shareholders, even if it's not all paid out. You should check if dividends and stock buybacks are covered by FCFE or if they're coming from somewhere else. Investors prefer when they're fully funded by FCFE. If FCFE is less than what's spent on dividends and buybacks, the company might be using debt, existing capital like retained earnings, or issuing new securities. I know some investors aren't fans of using debt for dividends, even at low rates, but borrowing for buybacks can make sense if shares are undervalued and prices go up later. If dividends are way below FCFE, the company is probably saving or investing the rest. And if spending on buybacks or dividends matches FCFE, then the firm is distributing it all to investors.
Example of How to Use FCFE
Take the Gordon growth model as an example: you can use FCFE to calculate the value of equity with this formula—V equity equals FCFE divided by (r minus g), where V equity is the stock's value today, FCFE is next year's expected FCFE, r is the cost of equity, and g is the growth rate in FCFE. This works best if capital expenditures aren't much higher than depreciation and if the company's stock beta is around 1 or less.
What Is Free Cash Flow to Equity (FCFE) Made Of?
FCFE is made up of capital expenditures, debt, net income, and working capital.
What Is the Formula for FCFE?
To get FCFE, take cash from operations, subtract capital expenditures, and add net debt issued.
Who Uses FCFE?
Analysts use free cash flow to equity to determine a company’s value.
The Bottom Line
Free cash flow to equity is an essential metric that shows the cash available to equity shareholders after expenses, reinvestments, and debt repayments. It indicates whether a company can fund its own dividends and share repurchases without outside help. For you as an investor, a strong FCFE points to good financial health and smart use of equity capital, making it a key tool for evaluating companies, especially those that don't pay dividends.
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