Two important questions to ask before you buy Pearson plc (LSE:PSON) is, how it makes money and how it spends its cash. 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 PSON’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. Check out our latest analysis for Pearson

What is free cash flow?

Pearson’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 Pearson to continue to grow, or at least, maintain its current operations. The two ways to assess whether Pearson’s FCF is sufficient, is to compare the FCF yield to the market index yield, as well as determine whether the top-line operating cash flows will continue to grow.

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

Despite its positive operating cash flow, after accounting for capital expenses required to run the business, Pearson is not able to generate positive FCF, leading to a negative FCF yield – not very useful for interpretation!

What’s the cash flow outlook for PSON?

Can PSON improve its operating cash production in the future? Let’s take a quick look at the cash flow trend PSON is expected to deliver over time. Over the next couple years, the company is expected to grow its cash from operations at a double-digit rate of 26.62%, ramping up from its current levels of £433.0M to £548.3M in three years’ time. Furthermore, breaking down growth into a year on year basis, PSON is able to increase its growth rate each year, from -29.23% in the upcoming year, to 25.26% by the end of the third year. The overall future outlook seems buoyant if PSON can maintain its levels of capital expenditure as well.

What this means for you:

Interested in learning more about Pearson’s fundamentals? To quickly understand whether it is a good investment for you, scroll through our FREE easy-to-understand infographics report. Not interested in Pearson anymore? How about checking out hidden opportunities in high-growth and undervalued stocks here.

To help readers see pass the short term volatility of the financial market, we aim to bring you a long-term focused research analysis purely driven by fundamental data. Note that our analysis does not factor in the latest price sensitive company announcements.

The author is an independent contributor and at the time of publication had no position in the stocks mentioned.