If you are currently a shareholder in ABB Ltd (VTX:ABBN), or considering investing in the stock, you need to examine how the business generates cash, and how it is reinvested. What is left after investment, determines the value of the stock since this cash flow technically belongs to investors of the company. I’ve analysed below, the health and outlook of ABBN’s cash flow, which will help you understand the stock from a cash standpoint. Cash is an important concept to grasp as an investor, as it directly impacts the value of your shares and the future growth potential of your portfolio.
See our latest analysis for ABB
What is free cash flow?
ABB’s free cash flow (FCF) is the level of cash flow the business generates from its operational activities, after it reinvests in the company as capital expenditure. This type of expense is needed for ABB to continue to grow, or at least, maintain its current operations.
There are two methods I will use to evaluate the quality of ABB’s FCF: firstly, I will measure its FCF yield relative to the market index yield; secondly, I will examine whether its operating cash flow will continue to grow into the future, which will give us a sense of sustainability.
Free Cash Flow = Operating Cash Flows – Net Capital Expenditure
Free Cash Flow Yield = Free Cash Flow / Enterprise Value
where Enterprise Value = Market Capitalisation + Net Debt
ABB’s yield of 3.03% indicates its sub-standard capacity to generate cash, compared to the stock market index as a whole, accounting for the size differential. This means investors are taking on more concentrated risk on ABB but are not being adequately rewarded for doing so.
Does ABB have a favourable cash flow trend?
Another important consideration is whether this return is likely to be maintained over the next couple of years. We can gauge this by looking at ABBN’s expected operating cash flows. In the next couple of years, the company is expected to grow its cash from operations at a double-digit rate of 41%, ramping up from its current levels of US$2.9b to US$4.1b in three years’ time. Although this seems impressive, breaking down into year-on-year growth rates, ABBN’s operating cash flow growth is expected to decline from a rate of 36% in the upcoming year, to -7.9% by the end of the third year. But the overall future outlook seems buoyant if ABBN can maintain its levels of capital expenditure as well.
Next Steps:
Given a low free cash flow yield, on the basis of cash, ABB becomes a less appealing investment. This is because you would be better compensated in terms of cash yield, by investing in the market index, as well as take on lower diversification risk. However, cash is only one aspect of investing. Keep in mind that cash is only one aspect of investment analysis and there are other important fundamentals to assess. You should continue to research ABB to get a better picture of the company by looking at: