Two important questions to ask before you buy Endava plc (NYSE:DAVA) is, how it makes money and how it spends its cash. After investment, what’s left over is what belongs to you, the investor. This also determines how much the stock is worth. Today we will examine Endava’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.
Is Endava generating enough cash?
Endava generates cash through its day-to-day business, which needs to be reinvested into the company in order for it to continue operating. What remains after this expenditure, is known as its free cash flow, or FCF, for short.
There are two methods I will use to evaluate the quality of Endava’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
Along with a positive operating cash flow, Endava also generates a positive free cash flow. However, the yield of 1.84% is not sufficient to compensate for the level of risk investors are taking on. This is because Endava’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 Endava?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 Endava’s expected operating cash flows. Over the next two years, a double-digit growth in operating cash of 44% is expected. The future seems buoyant if Endava can maintain its levels of capital expenditure as well. Below is a table of Endava’s operating cash flow in the past year, as well as the anticipated level going forward.
|Current||+1 year||+2 year|
|Operating Cash Flow (OCF)||UK£32m||UK£30m||UK£46m|
|OCF Growth Year-On-Year||-5.9%||53%|
|OCF Growth From Current Year||44%|
Given a low free cash flow yield, on the basis of cash, Endava becomes a less appealing investment. 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. Now you know to keep cash flows in mind, I recommend you continue to research Endava to get a better picture of the company by looking at:
- Valuation: What is DAVA 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 DAVA 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 Endava’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.
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If you spot an error that warrants correction, please contact the editor at firstname.lastname@example.org. This article by Simply Wall St is general in nature. It does not constitute a recommendation to buy or sell any stock, and does not take account of your objectives, or your financial situation. Simply Wall St has no position in the stocks mentioned. Thank you for reading.