Cash flow takes into consideration the company’s ability to generate COLD HARD CASH, it is very difficult to manipulate this metric through shady accounting methods.
When I say “Shady Accounting Methods” I am referring to one of Wall Street’s standard metrics for stocks, Earnings Per Share (EPS). Please make no mistake the accounting methods used by these companies are legal HOWEVER, they are very misleading.
For example, when using EPS, a company can take into account money it hasn’t technically received yet, they can post expenses to a later date, etc. These are the types of accounting methods Enron practiced that duped their investors.
This is a very hard concept to thoroughly understand and if you want to understand the difference between EPS and Cash Flow Per share I highly encourage you grab Joe Ponzio’s Book F Wall Street
If you choose not to, just remember, cash flow gives a more accurate value of the strength and sustainability of a business.
My rule of thumb for Cash Flow:
- I only pay between 8 – 10 times Cash Flow per share for operating companies
- I make a ONE TIME EXCEPTION for Dividend Kings in which I am willing to pay up to 15 times Cash Flow per share.