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Cash Flow Valuation- What items do you include/exclude and why?


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Hi all,

Curious to know what items from the cash flow statement you include/exclude when you are calculating cash flows and why? I've read that some use DCF and that Warren Buffett uses a variation of this- Owner's Earnings (Operating cash flows- maintenance capex). I've read arguments for excluding cash flows from investing and financing include that these items don't represent the 'core' business. However, I find it difficult to accept that  items such as payment of long-term debt should be excluded given we are trying to find intrinsic value- the net value of all cash inflows and outflows discounted at an appropriate rate. Discussion of any items you include/exclude in your cash flow calculation would be much appreciated.



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Rory, sounds like you could use more reading. I'd suggest McKinsey's valuation book (http://www.amazon.com/Valuation-Measuring-Managing-Companies-Edition/dp/0470424656). That being said, you want to make sure you're matching the cash flows you're measuring with the appropriate capital structure.


In general, my rule of thumb is operating cash flow - stock compensation - capex is a pretty good free cash flow metric (to the firm, meaning both equity and debt holders). If you're just focused on equity cash flows, then of course you need to strip out interest and debt repayments.

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I think you'd be better off with Greenwald's book. It goes through multiple logical ways of determining value. I like the McKinsey book as a business owner and for conceptual thinking, however, I would say it has done very little for me investing wise. It's written like you would expect McKinsey publications to be written.


Also, Pabrai's Dhando Investor gives really good and simple examples.


Basically take net income, add back depreciation, deduct capex. Or you can take cash flow from ops and deduct capex.


From reading interviews with Pabrai and others, most don't worry about trying to determine a maintenance level of capex. Greenwald gives some solid advice on how to determine a logical level of maintenance capex. I personally don't bother much with that level of detail or spreadsheets, instead I do like Pabrai. You're looking for a reasonable range of potential cash flows and a HUGE discount on them, aka margin of safety.

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