Net Profit, EBITDA, Operating Cashflow and Free Cashflow in Dividend Investing
On my Dividend Stock Tracker, I favored the ratios with operating cashflow free cashflow more than using net profit.
Edit: I have update my tracker as of 25th Oct ’10, now both operating cashflow and free cashflow are incorporated.
View the full tracker free
By that, I am refering to operating cashflow yield vs earnings yield and dividend yield.
Dividend – the most straight forward. This is what the declared cash payout to the shareholders.
Dividend Yield = Dividend per share for the year/Latest Share Price of Stocks
Many dividend yielders have a dividend policy to payout a certain percentage of their earnings
Net Profit – the accounting revenue less expenses.
Net Profit = Revenue – Operating Cost – Depreciation & Amortization – Interest Expense + Interest/Investment Income – Tax
Earnings Yield = Net Profit / latest share price
This would include taking into account taxes paid, interest paid and received and depreciation of assets as expense. Basically what most analyst are concern with.
EBITDA – this is net profit adding back interest and depreciation considerations.
EBITDA = Net Profit + Depreciation & Amortization + Interest Expense – Interest Income + Tax
EBITDA Yield = EBITDA per share / latest share price
Theoratically this is a bigger sum then net profit since depreciation on assets are quite substantial.
Operating Cashflow – this is the cashflow from operations taken from the cashflow statement in a company’s Annual Report
Operating Cashflow = Net Profit + Depreciation & Amortization – Interest/Dividend Income +Interest Expense +/- Change in disposable of plant and property + change in Receivables + change in Payables + change in Inventory
Operating Cashflow Yield = Operating Cashflow per share / latest share price
Why consider EBITDA over net profit?
When investing in a dividend stock our basis of analysis should be based on a company’s ability to pay out dividends annually and you need to have the cold hard cash in order to do that.
The commonality for most matured dividend yielders is that they are asset heavy and thus they have quite substantial depreciation. These are not exactly cash paid out but was an initial large cash investment. It is only to accrual the expense accross the servicable lifespan of the asset.
Simply put, the company does not have to pay this out which means that they can theoratically pay this out as part of dividend or for capex.
The common gauge is to see if a company is paying out more than it can is to see % dividend payout of profit.
I would think that gauging based on % payout of operating profit or EBITDA will be a better gauge.
Net Profit subjected to receivables manipulation
Receivable under accounting is counted as part of profits for that year but essentially the company have not recieved the cash. As such even though accounting wise you earn this in the year you can’t pay this out or use this for capex.
It is also likely that to boost profits a company can very easily tell it’s customer to pay later or to take the goods and return those that they cannot sell. This will book the big profits with high receivables and using a % payout of earnings as a gauge will be utterly misleading.
Thankfully most yielders don’t have high receivables but if you invest in one that does do watchout for this.
Why using operating cashflow is better over EBITDA
Using EBITDA won’t solve this problem as you normally start with net profit and work it out by adding the interest expense and taking away the interest income and adding back the depreciation. Your receivables will stil be in the EBITDA.
The operating cashflow is a favorite of mine because the cashflow statement shows how the company earns it’s cash and how it gets it’s financing.
It is normally split into 3 parts:
1) operating cashflow. This is where the company earns it’s cash from selling it’s goods and services.
2) investing cashflow. This is where it shows what capex the company need to grow in the future or maintain current assets.
3) financing cashflow. This is where it shows whether the company finance it’s business by taking more debts, equity issues and how much dividend gets paid out.
Insteading of using EBITDA, using operating cashflow is better as it factors in changes in inventory (too much increase over last year kills cashflow), receivables ( too much increase over last year kills cashflow) and payables (increase of payables benefits cashflow)
But do not use the ratio blindly. Understand what goes into the ratio and you will understand how the company operates better. Is too much payables beneficial to a company? You will not know if you only use the ratio.
Free Cashflow to rule them all
Still you will observe that for most companies that operate well, their operating cashflow yield is much much higher than their dividend payout yield. So are they keeping much more than necessary?
Not so. The operating cashflow is only one part of the equation.
We use only operating cashflow to analyze rather than cash inflows from financing and investing because we are interested to know if their core business generates cash to pay shareholders or for reinvestments.
Other inflows are typically one off and should not be taken as repeatable.
The cashflow earned can be used largely in 3 ways.
- Reduce longterm debts shown in the financing cashflow,
- pay to shareholders in the financing cashflow and
- invest in capital expenditure for growth or maintainence.
Free Cashflow normally refers to operating cashflow minus capex.
For alot of utilities that makes good dividend yielders, capex can be pretty high. So free cashflow will show that excess cashflow available to pay for div is actually much less.It is also a reason my dividend stock tracker will migrate to free cashflow instead of using operating cashflow. For most yielders the free cashflow shoud be positive compare to growth companies since some of them need to invest large amount on the on start.Some dividend yielders have shown that their free cashflow yields to be less than dividend yield consistently.
A good example is SPH.
SPH is a favorite stock for it’s yield and a business that cannot go wrong. A look at recent balance sheets have shown that sph now depends not just on it’s printing and publishing business to pay dividend and capex but also property. It’s free cashflow is consistently negative taking away the cashflow from property investments. As an investor you would need to evaluate whether not having a recurring cashflow that is able to sustain it’s yield is good enough for you.
I run a free Singapore Dividend Stock Tracker available for everyone’s perusal. Do follow my Dividend Stock Tracker which is updated nightly here.
Related posts:
- Free Cashflow Yield incorporated into Dividend Stock Tracker
- M1 Full Year Results 2010: Paying out more than free cashflow
- Introducing my Dividend Stock Tracker
- Revised Projected Dividend [Dividend Stock Tracker]
- VICOM cashflow
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Comments
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[Quote]A good example is SPH.
It’s free cashflow is consistently negative taking away the cashflow from property investments.[Quote]
I don’t know how you calculate free cashflow by taking away the cashflow from property investments. But I am curious that You put SPH free cashflow is consistently negative.
Cashflow from operating activities
FY2002 – 89M
FY2003 –
FY2004 – 73M
FY2005 –
FY2006 – 0.1M
FY2007 – 57M
FY2008 – 24M
FY2009 –
SPH cashflow from operating activities is after dividend payment. That mean dividend payment need to add back to get REAL operating cashflow. Since SPH dividend payments range from 195M to 433M, what I see is consistently POSITIVE operating cashflow. Yes that include FY2009.
Of course, CAPEX(new or maintanence) must be deducted to get free cashflow and for SPH case, whether SPH is using investment gains/incomes to finance CAPEX or otherwise, SPH is consistently generating cash from investment activities. Which mean it doesn’t matter how one count them, SPH is generating free cashflow consistently.
So I do not agree with your analysis and why don’t you put down the number and lets see why the diff.