Free Cash FLow

Free cash flow (FCF) measures how much money a company makes after deducting maintenance capex, but before capex on expansion. This is important as it allows valuation of the existing business without the harder to asses value of investment in expansion and new ventures. The latter should be worth more than the money that is being invested in them. How much more is hard to assess and valuing companies using their free cash flow sidesteps the question. This means that using free cash flow based valuations will undervalue companies which have particularly good opportunities to invest. It will also mean that it will overvalue companies which are sufficiently badly run to make investments that destroy shareholder value. The latter is not as uncommon as it should be because managers usually benefit by expanding more than is in the best interests of shareholders. The free cash flow is the same as what the dividends would be if a company decided to pay out as much as it could in dividends without either running down its operations or increasing debt. Free cash flow (FCF) is often used in discounted cash flow valuations.