SPS Commerce Inc (NASDAQ:SPSC) shareholders, and potential investors, need to understand how much cash the business makes from its core operational activities, as well as how much is invested back into the business. After investment, what’s left over is what belongs to you, the investor. This also determines how much the stock is worth. I will take you through SPSC’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.
What is free cash flow?
Free cash flow (FCF) is the amount of cash SPS Commerce has left after it pays off its expenses, including its net capital expenditures, which is what the company needs to spend each year to maintain or grow its business operations.
I will be analysing SPS Commerce’s FCF by looking at its FCF yield and its operating cash flow growth. The yield will tell us whether the stock is generating enough cash to compensate for the risk investors take on by holding a single stock, which I will compare to the market index. The growth will proxy for sustainability levels of this cash generation.
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
SPS Commerce’s yield of 2% indicates its sub-standard capacity to generate cash, compared to the stock market index as a whole, accounting for the size differential. This means investors are taking on more concentrated risk on SPS Commerce but are not being adequately rewarded for doing so.
What’s the cash flow outlook for SPS Commerce?Does SPSC’s future look brighter in terms of its ability to generate higher operating cash flows? This can be estimated by examining the trend of the company’s operating cash flow moving forward. In the next few years, the company is expected to grow its cash from operations at a double-digit rate of 27%, ramping up from its current levels of US$47m to US$59m in two years’ time. Furthermore, breaking down growth into a year on year basis, SPSC is able to increase its growth rate each year, from 12% next year, to 14% in the following year. The overall future outlook seems buoyant if SPSC can maintain its levels of capital expenditure as well.
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. However, cash is only one aspect of investing. Keep in mind that cash is only one aspect of investment analysis and there are other important fundamentals to assess. You should continue to research SPS Commerce to get a better picture of the company by looking at:
- Valuation: What is SPSC worth today? Is the stock undervalued, even when its growth outlook is factored into its intrinsic value? The intrinsic value infographic in our free research report helps visualize whether SPSC is currently mispriced by the market.
- Management Team: An experienced management team on the helm increases our confidence in the business – take a look at who sits on SPS Commerce’s board and the CEO’s back ground.
- Other High-Performing Stocks: If you believe you should cushion your portfolio with something less risky, scroll through our free list of these great stocks here.
To help readers see past the short term volatility of the financial market, we aim to bring you a long-term focused research analysis purely driven by fundamental data. Note that our analysis does not factor in the latest price-sensitive company announcements.
The author is an independent contributor and at the time of publication had no position in the stocks mentioned. For errors that warrant correction please contact the editor at firstname.lastname@example.org.