Is there a secret to find the great stock?

The answer is no, there are no secrets… but there is a process and there are steps, you just need to learn about them.

And like any other learning experience, it is a mix of trial and errors, intuition, and bit of luck.

After learning for few years, I arrived to a process to find great stocks.

So, what’s this financial key?

Simply put, I want a business with positive and reliable free cash flow.

Free cash flow is all the excess cash profit left over after a business pays all its expenses and taxes and after it reinvests enough cash to maintain and grow the business.

Remember, when you buy a stock, you’re buying a piece of a business.

It’s not a debt, and it’s not a preferred stock.

It’s equity.

And equity is a “residual claim” on the earnings of a business.

“Residual” just means the equity holder doesn’t get paid until everybody else gets paid. This is really important.

What does that mean?

It means, there’s nothing left over for equity holders until all secured and unsecured creditors, salary and wage earners, taxes, and preferred stock holders all get paid.

Only after all these obligations are met, you, the equity holder, expect your shares to be worth anything.

In fact, excess cash flows are the one thing that give your stock nearly all of its value.

It makes sense, right?

 

This is what makes a business valuable:

 

The ability to generate lots of extra cash.

Without excess cash, your shares are worthless.

Free cash flow is easy to find.

All you do is go to the cash flow financial statement

“cash flow” section,

and subtract “capital expenditures” from “operating cash flow.”

Sometimes operating cash flow is called “cash from operations”

or “net cash from operations.”

And sometimes, capital expenditures are called

“additions to property and equipment” or something similar.

Take software giant Apple (AAPL), for example in 2021,

Here’s how I calculate Apple’s free cash flow:

Cashflow from operations is $104 billion.

Let’s subtract $11 billion for additions to property and equipment.

This equals $93 billion.

That’s a lot of free cash flow.

Very few businesses generate as much free cash flow as Apple.

What’s interesting is most people have no idea how important this financial key is, so they’re unable to understand what an amazingly good business Apple really is right now.

To sum up:

1- Free cash flow is all the excess cash left over after a business pays all its expenses and taxes and reinvests enough to maintain and grow itself.

2- Free cash flow is important because it’s the amount of excess cash available for creating shareholder value, which is how you make the most money.

3- Free cash flow = cash from operations minus property and equipment spending. Both those numbers are on the cash flow statements inside a company’s quarterly and annual reports.

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