Xero Limited (ASX:XRO) 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 Xero’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. See our latest analysis for Xero
What is Xero’s cash yield?Free cash flow (FCF) is the amount of cash Xero 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. There are two methods I will use to evaluate the quality of Xero’s FCF: firstly, I will measure its FCF yield relative to the market index yield; secondly, I will examine whether its operating cash flow will continue to grow into the future, which will give us a sense of sustainability.
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
After accounting for capital expenses required to run the business, Xero is not able to generate positive FCF, leading to a negative FCF yield – not very useful for interpretation!
Does Xero have a favourable cash flow trend?Does Xero’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 going forward. In the next few years, a doubling in growth of operating cash flows is extremely uplifting, especially if capital expenditure grows at a lower rate. Below is a table of Xero’s operating cash flow in the past year, as well as the anticipated level going forward.
|Current||+1 year||+2 year||+3 year|
|Operating Cash Flow (OCF)||NZ$15.04M||NZ$62.24M||NZ$106.27M||NZ$154.51M|
|OCF Growth Year-On-Year||313.78%||70.73%||45.40%|
|OCF Growth From Current Year||606.47%||927.21%|
Keep in mind that cash is only one aspect of investment analysis and there are other important fundamentals to assess. I suggest you continue to research Xero to get a more holistic view of the company by looking at:
- Valuation: What is XRO 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 XRO 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 Xero’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.