Two important questions to ask before you buy Meggitt PLC (LON:MGGT) 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 will take you through MGGT’s cash flow health and the risk-return concept based on the stock’s cash flow yield, using the most recent financial data. This will help you think about the company from a cash perspective, which is a crucial factor to investing.

See our latest analysis for Meggitt

Is Meggitt generating enough cash?

Meggitt’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 Meggitt to continue to grow, or at least, maintain its current operations.

There are two methods I will use to evaluate the quality of Meggitt’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

Along with a positive operating cash flow, Meggitt also generates a positive free cash flow. However, the yield of 4.6% is not sufficient to compensate for the level of risk investors are taking on. This is because Meggitt’s yield is well-below the market yield, in addition to serving higher risk compared to the well-diversified market index.

Does Meggitt have a favourable cash flow trend?

Can MGGT improve its operating cash production in the future? Let’s take a quick look at the cash flow trend the company is expected to deliver over time. In the next few years, the company is expected to grow its cash from operations at a double-digit rate of 10%, ramping up from its current levels of UK£380m to UK£420m in three years’ time. Furthermore, breaking down growth into a year on year basis, MGGT is able to increase its growth rate each year, from -3.7% in the upcoming year, to 9.1% by the end of the third year. The overall picture seems encouraging, should capital expenditure levels maintain at an appropriate level.

Next Steps:

Although its positive operating cash flow, and high future growth, is appealing, the low free cash flow yield is unattractive. 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. Now you know to keep cash flows in mind, I suggest you continue to research Meggitt to get a better picture of the company by looking at: