If you are currently a shareholder in Cadence Design Systems, Inc. (NASDAQ:CDNS), or considering investing in the stock, you need to examine how the business generates cash, and how it is reinvested. What is left after investment, determines the value of the stock since this cash flow technically belongs to investors of the company. Today we will examine Cadence Design Systems’s ability to generate cash flows, as well as the level of capital expenditure it is expected to incur over the next couple of years, which will result in how much money goes to you.
View our latest analysis for Cadence Design Systems
What is free cash flow?
Free cash flow (FCF) is the amount of cash Cadence Design Systems 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 Cadence Design Systems’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
Along with a positive operating cash flow, Cadence Design Systems also generates a positive free cash flow. However, the yield of 3.08% is not sufficient to compensate for the level of risk investors are taking on. This is because Cadence Design Systems’s yield is well-below the market yield, in addition to serving higher risk compared to the well-diversified market index.
What’s the cash flow outlook for Cadence Design Systems?
Another important consideration is whether this return is likely to be maintained over the next couple of years. We can gauge this by looking at Cadence Design Systems’s expected operating cash flows. In the next couple of years, Cadence Design Systems’s operating cash flows is expected to grow by a double-digit 32%, which is encouraging, should capital expenditure levels maintain at an appropriate level. Below is a table of Cadence Design Systems’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) | US$600m | US$609m | US$681m | US$790m |
| OCF Growth Year-On-Year | 1.6% | 12% | 16% | |
| OCF Growth From Current Year | 14% | 32% |
Next Steps:
The company’s low yield relative to the market index means you are taking on more risk holding the single-stock Cadence Design Systems as opposed to the diversified market portfolio, and being compensated for less. Though the high operating cash flow growth in the future could change this. 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 Cadence Design Systems to get a more holistic view of the company by looking at:
- Valuation: What is CDNS 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 CDNS 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 Cadence Design Systems’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 editorial-team@simplywallst.com.