Free cash flow per share: Meaning, Criticisms & Real-World Uses

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What Is Free Cash Flow Per Share?

Free cash flow per share (FCFPS) is a financial metric within the broader category of financial metrics that measures the amount of free cash flow a company generates for each outstanding share of its common stock. This metric indicates a company's financial flexibility and its capacity to fund various activities after covering its operational expenses and necessary capital investments⁵⁷. Free cash flow per share is considered a robust indicator of a company's financial health, reflecting the actual cash available to be distributed to shareholders, reinvested in the business, or used to pay down debt ⁵⁶. It serves as a proxy for measuring changes in earnings per share.

History and Origin

The concept of evaluating a company's financial performance beyond reported earnings has evolved alongside modern accounting practices. While "free cash flow per share" as a specific metric doesn't have a single, definitive inventor, its underlying components, namely cash flow analysis and per-share metrics, gained prominence with the development of standardized financial reporting.

The push for standardized financial reporting, which forms the basis for calculating metrics like free cash flow per share, intensified in the early 20th century, particularly after events such as the stock market crash of 1929 and the Great Depression. In the United States, this led to the creation of the Securities and Exchange Commission (SEC) in 1934, tasked with regulating the securities industry and enforcing consistent financial reporting standards. Simultaneously, the American Institute of Certified Public Accountants (AICPA) established principles that laid the groundwork for U.S. Generally Accepted Accounting Principles (GAAP)⁵³, ⁵⁴, ⁵⁵. Globally, the International Accounting Standards Committee (IASC) was formed in 1973 (later succeeded by the International Accounting Standards Board, or IASB, in 2001, which developed International Financial Reporting Standards or IFRS) to harmonize accounting practices across countries⁵¹, ⁵².

As financial analysis matured, the focus shifted beyond accrual-based earnings to cash generation, recognizing that a company's ability to generate cash is crucial for its long-term viability and ability to return value to shareholders⁵⁰. Analysts and investors began to emphasize metrics like free cash flow, which directly measures cash available after necessary reinvestments, and subsequently, per-share versions like free cash flow per share, to provide a per-share perspective on this cash-generating capacity.

Key Takeaways

Free cash flow per share indicates the cash a company generates per outstanding share after accounting for operating expenses and capital investments.
It is a vital metric for assessing a company's financial flexibility and its ability to pay dividends, repurchase shares, or reduce debt.
A consistently high or increasing free cash flow per share generally signals strong financial health.
This metric is less susceptible to accounting distortions than accrual-based earnings figures.
It is widely used in valuation models and for comparing companies within the same industry.

Formula and Calculation

The formula for free cash flow per share is derived by dividing a company's total free cash flow by its total number of shares outstanding.

\text{Free Cash Flow Per Share} = \frac{\text{Free Cash Flow}}{\text{Number of Outstanding Shares}}

Where:

Free Cash Flow (FCF): This represents the cash flow generated by a company's operations after deducting the capital expenditures required to maintain or expand its asset base⁴⁸, ⁴⁹. Morningstar, for instance, calculates FCF as operating cash flow minus capital spending⁴⁷.
Number of Outstanding Shares: This is the total number of common shares currently held by all shareholders⁴⁶.

Some variations of the formula might subtract preferred dividend payments from free cash flow before dividing by common shares outstanding, especially when evaluating the cash available specifically for common shareholders⁴⁵.

Interpreting the Free Cash Flow Per Share

Interpreting free cash flow per share involves more than just looking at a single number; it requires context, trend analysis, and industry comparison. A higher free cash flow per share generally indicates a financially healthy company with ample cash to pursue growth opportunities, issue dividends, conduct share buybacks, or pay down debt⁴³, ⁴⁴.

Investors often track the trend of free cash flow per share over several periods. An increasing trend suggests an improving ability to generate cash from core operations, which can positively impact the stock price and shareholder value in the long run⁴². Conversely, a declining free cash flow per share may signal operational challenges or increased capital requirements.

It is also crucial to compare a company's free cash flow per share with its competitors and industry averages. What might be considered a strong FCFPS in one capital-intensive industry could be viewed as modest in another less capital-intensive sector⁴¹. For example, a mature company might exhibit high FCFPS because it has fewer growth-related capital expenditures, whereas a rapidly growing company might have lower or even negative FCFPS due to significant investments in expansion⁴⁰.

Hypothetical Example

Consider "Tech Innovations Inc." (TII), a publicly traded software company.

For the fiscal year, TII reported:

Operating cash flow: $150 million
Capital expenditures: $30 million
Number of outstanding shares: 50 million

First, calculate the Free Cash Flow (FCF):
FCF = Operating Cash Flow - Capital Expenditures
FCF = $150 million - $30 million = $120 million

Now, calculate the Free Cash Flow Per Share:
Free Cash Flow Per Share = FCF / Number of Outstanding Shares
Free Cash Flow Per Share = $120 million / 50 million shares = $2.40 per share

This means that for every share of Tech Innovations Inc. common stock, the company generated $2.40 in free cash flow, representing the cash available after covering its core business operations and reinvesting in its assets. An investor could then compare this $2.40 FCFPS to TII's historical FCFPS, its peers, or use it in a valuation model to assess the company's attractiveness.

Practical Applications

Free cash flow per share is a versatile metric used across various financial analyses:

Investment Analysis and Valuation: Investors frequently use free cash flow per share to assess a company's intrinsic value. It is a key input in discounted cash flow (DCF) models, which project future free cash flows to determine a company's present value³⁸, ³⁹. A higher FCFPS often indicates a more valuable company, all else being equal. Financial information, including data necessary to calculate free cash flow per share, is publicly available through SEC filings for publicly traded companies³⁶, ³⁷. For example, a company like Apple Inc. files annual reports (Form 10-K) with the SEC, which contain the financial statements needed for such analysis³³, ³⁴, ³⁵.
Dividend Sustainability: Companies with a consistent and growing free cash flow per share are typically better positioned to pay and increase dividends to shareholders³². This metric helps investors gauge the likelihood of future dividend payments.
Share Buybacks: A robust free cash flow per share allows companies to repurchase their own shares, which can reduce the number of outstanding shares and potentially boost earnings per share and stock price.
Debt Repayment: Companies with strong free cash flow per share have greater capacity to repay debt, reducing financial risk and improving their overall financial health ³¹.
Benchmarking and Comparison: Free cash flow per share allows for more meaningful comparisons between companies, especially those with different accounting policies or revenue recognition methods, as it focuses on actual cash generation³⁰. Financial data providers like Morningstar track and analyze free cash flow metrics for public companies²⁷, ²⁸, ²⁹.

Limitations and Criticisms

While free cash flow per share is a valuable metric, it is not without limitations:

Lack of Standardization: There is no single, universally accepted definition or formula for calculating free cash flow, which can lead to variations in reported figures across different sources or companies²⁵, ²⁶. This lack of standardization can make direct comparisons challenging and requires analysts to understand the specific calculation methodology used.
Sensitivity to Assumptions: Free cash flow per share is often based on projections of future cash flow, which are inherently uncertain and rely on various assumptions (e.g., revenue growth, profit margins, capital expenditures)²⁴. Small changes in these assumptions can significantly impact the resulting FCFPS figures.
Ignores Growth Potential and Underinvestment: A high free cash flow per share might sometimes indicate underinvestment in growth opportunities, particularly for mature companies that are not reinvesting heavily in their business²², ²³. Conversely, a young, rapidly growing company might show low or negative FCFPS because it is investing heavily for future expansion, which is not necessarily a negative sign²¹. Over-reliance on FCFPS as a performance measure can incentivize managers to forgo value-creating investments that might decrease FCF in the short term, potentially leading to long-term underperformance²⁰.
Does Not Capture Full Value: Free cash flow per share may not fully capture the value of a company's strategic options, such as its ability to enter new markets or acquire new technologies. These factors may not immediately generate cash flow but can significantly enhance long-term value¹⁹.
Impact of Non-Recurring Items: Extraordinary events or non-recurring items can distort a company's free cash flow, making it difficult to assess its sustainable cash-generating ability. Analysts often need to adjust FCF for such items to get a clearer picture¹⁸.

Free Cash Flow Per Share vs. Earnings Per Share

Free cash flow per share (FCFPS) and earnings per share (EPS) are both per-share metrics used to evaluate a company's financial performance, but they reflect different aspects. The primary difference lies in their underlying accounting methodologies:

Feature	Free Cash Flow Per Share (FCFPS)	Earnings Per Share (EPS)
Focus	Measures actual cash generated by the company's operations after accounting for necessary capital investments¹⁷.	Measures a company's net profit allocated to each outstanding common share¹⁶.
Accounting Method	Cash-based, reflecting the true liquidity of the business¹⁵. Less susceptible to non-cash items and accounting judgments¹⁴.	Accrual-based, recognizing revenues when earned and expenses when incurred, regardless of when cash is exchanged¹³.
Manipulability	Generally harder to manipulate as it tracks real cash movements.	Can be influenced by accounting policies, non-cash items (like depreciation), and management discretion¹¹, ¹².
Indicates	Financial flexibility, ability to pay dividends, repurchase shares, or reduce debt ¹⁰.	Profitability and the portion of net income available to common shareholders.

While EPS is a widely reported and easily understood metric of profitability, FCFPS provides a more realistic view of a company's ability to generate cash that can be used for discretionary purposes⁹. Companies can report high earnings but have poor free cash flow due to issues like aggressive revenue recognition or slow collection of receivables⁸. Therefore, many investors use both metrics in conjunction to gain a comprehensive understanding of a company's financial standing.

FAQs

What is considered a good free cash flow per share?

There is no universal "good" free cash flow per share number, as it varies significantly by industry, company size, and growth stage⁷. Generally, a consistently positive and increasing FCFPS over time is a positive sign, indicating a company's ability to generate sufficient cash to fund its operations, invest in growth, and reward shareholders⁵, ⁶. It's crucial to compare a company's FCFPS to its historical performance and to its peers within the same industry to determine if it is strong.

Why is free cash flow per share important for investors?

Free cash flow per share is important for investors because it provides insight into a company's financial health and its capacity to generate cash that can be used to create shareholder value⁴. Unlike earnings per share, which can be influenced by non-cash accounting entries, FCFPS focuses on the actual cash available. This cash can be used for various purposes, including paying dividends, executing share buybacks, reducing debt, or investing in future growth, all of which can ultimately impact the company's stock price³.

How does free cash flow per share relate to company valuation?

Free cash flow per share is a fundamental component in many company valuation methodologies, particularly discounted cash flow (DCF) analysis. DCF models project a company's future free cash flows and discount them back to their present value to estimate the company's intrinsic worth². A higher projected free cash flow per share generally leads to a higher valuation. Additionally, FCFPS is often used in conjunction with other metrics, such as price-to-free cash flow (P/FCF), where a company's market capitalization is compared to its free cash flow, offering another perspective on valuation¹.