The Georgia Tech Financial Analysis Lab conducts unbiased research on issues of financial reporting and analysis. Unbiased information is vital to effective investment decision-making. Accordingly, we think that independent research organizations, such as our own, have an important role to play in providing information to market participants.

Because our lab is housed within a university, all of our research reports have an educational quality, as they are designed to impart knowledge and understanding to those who read them. Our focus is on issues that we believe will be of interest to a large segment of stock market participants. Depending on the issue, we may focus our attention on individual companies, groups of companies, or on large segments of the market at large.

A recurring theme in our work is the identification of reporting practices that give investors a misleading signal, whether positive or negative, of corporate earning power. We define earning power as the ability to generate a sustainable stream of earnings that is backed by cash flow. Accordingly, our research may look into reporting practices that affect either earnings or cash flow, or both. At times our research may look at stock prices generally, though from a fundamental and not technical point of view.

Cash Flow Trends and Their Fundamental Drivers: Comprehensive Review

Quarter 3, 2019

Free Cash Margin Index:

Recession Lows 0.99%, 3.45% (Dec. 2000, Dec. 2008) Current 3.92% (Sep. 2019) Recent High 6.88% (Dec. 2009)

March 2020

Median free cash margin increased slightly to 3.92% for the twelve months ending September 2019, compared with 3.83% for the twelve months ending June 2019 but decreased from 4.10% in September 2018. Median revenues decreased to $1,167.45 million in the current period from $1,194 million in June 2019 and $1,214.24 million in September 2018.

When compared with September 2018, a decline in operating cushion to 13.39% in September 2019 from 14.30% in September 2018 and an increase in the cash cycle to 50.59 days in September 2019 from 48.92 days in September 2018 pushed free cash margin lower in the September 2019 reporting period. The drop in operating cushion was driven by a decline in gross margin and an increase in SG&A as a percent of revenue. The cash cycle was pushed higher by an increase in receivables days and inventory days and a decline in payables days.

Capital expenditures decreased to 3.65% in the current quarter compared to 3.68% in June 2018 and 2.80% in September 2018 and helped to mitigate the decline in free cash margin.

With declining revenues and capital spending, the results for the September 2019 reporting period show economic weakness and declining business confidence. Rising cash levels as a percent of revenue and declining dividends and stock repurchases also show caution.

Quarter 2, 2019

Free Cash Margin Index:

Recession Lows 0.99%, 3.45% (Dec. 2000, Dec. 2008) Current 3.83% (Jun. 2019) Recent High 6.88% (Dec. 2009)

Median free cash margin slightly decreased to 3.83% for the twelve months ending June 2019, compared to 3.90% for the twelve months ending March 2019 and 4.04% in June 2018. Median free cash margin dropped again from the previous quarter after increasing for the first time in December 2018 since June 2017. Median revenues have also decreased to $1,194 million in June 2019 compared to $1,234.73 million in March 2019.

Driving the fall in free cash margin was a marginal decrease in median operating cushion, which fell to 14.06% in the June 2019 reporting period compared to 14.09% in the March 2019 reporting period and 14.35% in the June 2018 reporting period. Gross margin marginally dropped from 37.26% in June 2019 from 37.27% in March 2019 but improved on a year over year basis from 37.08% in June 2018. SG&A spending as a percentage of revenue also decreased to 17.57% in June 2019 from 17.68% in March 2019 and but increased substantially compared to 16.99% in June 2018. An increase in the cash cycle favored this period’s fall in free cash margin. The cash cycle rose to 51.38 days in the June 2019 reporting period compared to 50.81 days in March 2019 but decreased from 52.78 days in June 2018. This increase in the cash cycle was driven primarily by an increase in inventory days, which rose from 22.72 in March 2019 to 23.35 in June 2019. Receivables days and payables days slightly increased from the previous quarter.

Capital expenditures increased to 3.68% in the current quarter compared to 3.64% in March 2018. Tax payments moderately increased from 0.92% in March 2019 to 0.95% in June 2019. Dividends and stock buybacks as a percent of revenue also fell from 2.06% in March 2019 to 1.97% in June 2019 but were up year-over-year from 1.90% in June 2018.

Cash Flow Trends and Their Fundamental Drivers: Comprehensive Review

Quarter 1, 2019

Free Cash Margin Index:

Recession Lows 0.99%, 3.45% (Dec. 2000, Dec. 2008) Current 3.90% (Mar. 2019) Recent High 6.88% (Dec. 2009)

September 2019

Median free cash margin decreased to 3.90% for the twelve months ending March 2019, compared to 4.39% for the twelve months ending December 2018 and 4.17% in March 2018. Median free cash margin dropped from the previous quarter after increasing for the first time in December 2018 since March 2017. Median revenues have also decreased to $1,234.73 million in March 2019 compared to $1,248.26 million in December 2018.

Driving the fall in free cash margin was a decrease in median operating cushion, which fell to 14.09% in the March 2019 reporting period compared to 15% in the December 2018 reporting period and 14.53% in the March 2018 reporting period. This decrease in median operating cushion was driven by a drop in gross margin to 37.27% in March 2018 from 37.42% in December 2018 and 37.65% in March 2018 and a rather sharp increase in SG&A spending as a percentage of revenue, which increased to 17.68% in March 2019, up from 16.29% in December 2018 and 17.17% in March 2018. An increase in the cash cycle further favored this period’s fall in free cash margin. The cash cycle rose to 50.81 days in the March 2019 reporting period compared to 47.77 days in December 2018 and 50.01 days in March 2018. This increase in the cash cycle was driven primarily by an increase in inventory days, which rose from 20.60 in December 2018 to 22.72 in March 2019. Receivables days increased and payables days slightly declined from the previous quarter.

Capital expenditures also decreased to 3.64% in the current quarter compared to 3.79% in December 2018. Tax payments moderately decreased from 0.96% in December 2018 to 0.92% in March 2019. Dividends and stock buybacks as a percent of revenue also fell from 2.15% in December 2019 to 2.06% in March 2019 but were up year-over-year from 1.65% in March 2018.

Quarter 4, 2018

Free Cash Margin Index:

Recession Lows 0.99%, 3.45% (Dec. 2000, Dec. 2008) Current 4.39% (Dec. 2018) Recent High 6.88% (Dec. 2009)

Median free cash margin increased to 4.39% for the twelve months ending December 2018, compared to 4.01% for the twelve months ending September 2018 and 4.59% in December 2017. Median free cash margin has increased for the first time compared to a previous quarter since March 2017. Median revenues have also seen a turnaround and have increased to $1,248.26 million in December 2018 compared to $1,238.43 million in September 2018, marking the end of four consecutives periods of falling revenues since the record high posted in December 2017.

Driving the rise in free cash margin was an increase in median operating cushion, which rose to 15% in the December 2018 reporting period, compared to 14.29% in September 2018 and 14.45% in December 2017. This increase in median operating cushion was driven by a rather sharp decrease in SG&A spending as a percentage of revenue, which fell to 16.29% in December 2018, down from 17.63% in September 2018 and 17.26% in December 2017. A slight reduction in the cash cycle favored this period’s rise in free cash margin. The cash cycle fell to 47.77 revenue days in the December 2018 reporting period, down from 48.81 days reported in September 2018 and 52.16 days in December 2017. This decline in the cash cycle was driven primarily by a reduction in inventory days, which fell from 22.15 in September 2018 and 24.61 in December 2017 to a record low of 20.60 days in this most recent reporting period. Receivables days and payables days also declined from the previous quarter.

Capital expenditures also increased to 3.79% in the current quarter compared to 3.58% in September 2018. This was a record high since the 3.89% in December 2016. Tax payments significantly increased from 0.55% in September 2018 and 0.80% in December 2017 to 0.96% in December 2018. Dividends and stock buybacks as a percent of revenue continue to climb, as they rose to 2.15% in December 2018, up from 1.92% in September 2018 and 1.59% in

December 2017.

The recent tax reform bill was signed into law in December 2017 with the hope that lower corporate taxes would increase capital spending and spur general economic growth. We are finally seeing an increase in capital spending as capital expenditures as a percent of revenue have increased for the first time since the tax law change took effect. We also see evidence of economic growth in the form of increasing median revenues. Finally, defying expectations for declining margins that typically occur late in an economic expansion, we saw an improvement in operating cushion.

The Free Cash Profile: Insights into the cash flow implication of growth.

June 2019

As the U.S. economy continued its recovery in 2018 amidst the passage of the tax reform bill in 2017, companies enjoyed the benefits of revenue growth. In terms of cash flow generation, as revenues grow, there are certain industries and companies that will benefit more than others. It is a common misbelief that growth requires a use of cash. The reality is that there are many companies that actually generate increasing amounts of free cash flow as revenues grow. These companies have what we refer to here as a positive free cash profile.

The purpose of this study is to analyze the free cash profile of 20 non-financial industries, looking at all firms within those industries that have assets in excess of $100 million. Our goal is to identify those industries that can be expected to generate cash as revenues continue to grow, as well as those industries that will consume cash with growth. We also highlight specific industries to investigate factors underlying their free cash profile.

Overall, the median free cash profile for our sample is 7.10%, a notable increase from 2017’s median at 5.98%. There are 13 industries with a positive free cash profile, and 7 industries with a negative free cash profile. Industries with positive free cash profiles enjoy higher operating cushions and are more adept at managing operating working capital and limiting capital spending than industries with negative profiles. It is important to note that although industries have median positive (negative) free cash profiles, a number of companies within those industries may have negative (positive) free cash profiles.

Latest Reports

The Inclusion of Short-Term Investments In Operating Cash Flow

April 2019

In this study we examine the effects of including the proceeds from trading securities in operating cash flow. While generally accepted accounting principles call for the inclusion in operating activities of cash flows related to the purchase and sale of trading securities, such treatment can be misleading for non-financial companies, where trading activities are not part of normal business operations.

We first looked at this question in 2003. The current study revisits those findings and extends them using 2017 data. The results indicate that non-financial companies are less likely in 2017 to classify short-term investments as trading securities and report their cash flow effects in operating cash flow than in 2003. Analysts, investors and other users of the statement of cash flows are well served by this development.

Revisiting the Financial Statement Treatment of Goodwill

February 2019

Goodwill arises when a company is acquired at a price that exceeds the fair market value of its identifiable net assets. Accounting for goodwill has evolved over the years from one of writing it off directly against equity to one of reporting it as an asset subject to amortization, to today’s treatment, as codified in ASC 350-20, that calls for it to be carried as an asset without amortization but reviewed annually for impairment. In recent years, goodwill has steadily increased as a percentage of total assets. With the growing size of goodwill comes the growing risk that carrying goodwill on the balance sheet without amortization may overstate perceptions of company performance. In effect, the acquisition premium represented by goodwill has no readily apparent cost because there is no regular earnings impact in the form of a recurring expense. Further, total assets and shareholders’ equity are reported at higher amounts.



This research report examines the validity of concerns surrounding goodwill’s growing balance sheet presence through the lens of commonly used financial metrics. For a large sample of firms, we calculate return on equity (ROE), net margin, asset turnover, and financial leverage while assuming that goodwill is written off to equity, carried as an asset, or amortized as an expense.



Carrying goodwill without amortization leads to an average net margin that is 15.2% higher (6.4% vs. 5.6%) than when goodwill is amortized over an assumed 20-year amortization period. However, because asset turnover and financial leverage are higher under an amortization approach, there is little difference in return on equity. Average ROE when goodwill is not amortized is 7.8%, vs. 7.7% when goodwill amortization is included as an expense in measuring net income.



Our recommendation to analysts is to be alert for goodwill on company balance sheets. As seen here, the number of companies reporting goodwill and the amount of that goodwill are growing. When present, analysts must keep in mind that no recurring expense for goodwill is being reported. As such, net margin and ROE are higher than if goodwill were amortized. Those additional unamortized assets, however, are lowering asset turnover and financial leverage and raising the risk of a future goodwill impairment charge.

Adjusting Free Cash Flow for Non-Cash Capital Expenditures, Capital Leases and the Capitalized Value of Operating Leases

January 2019

In this study we calculate free cash flow adjusted to include non-cash capital expenditures, capital leases and the capitalized value of operating leases. All of these transactions reflect the acquisition of the services of capital assets but entail no up-front cash disbursement because financing is provided, either from the equipment vendor or a financial institution, such that the company in question does not actually receive or disburse any cash. Such investments are capital expenditures and result in the recording of a fixed asset and a related obligation on the balance sheet. But because they entail no receipt or disbursement of cash, they are excluded from capital expenditures on the statement of cash flows.



Our sample consists of the 82 non-financial firms of the S&P 100 for the years 2015 and 2016. For some firms, for example, Amazon.com, Inc., General Electric and Kraft Heinz, adjusted free cash flow is lower than reported free cash flow by ten percent or more in at least one of the two years sampled. But for most firms, adjusted free cash flow is greater than reported free cash flow in both years. In fact, on average, in both 2015 and 2016, adjusted free cash flow exceeds reported free cash flow by five percent. This unexpected result is due to the fact that rent expense is already included in operating cash flow, and thus, free cash flow. In most cases, current rent expense, which must be added back in calculating adjusted free cash flow, exceeds the deduction to free cash flow made for the increase in the capitalized value of operating leases. Our results are presented in a series of tables where the effects of our adjustments on each sample firm are shown.



Financial analysts and investors should find these results to be of interest because valuations on a price to free cash flow basis may be lower than they were otherwise thought to be. Corporate managers may find it worthwhile to incorporate the adjustments highlighted here when presenting pro-forma measures of cash flow to shareholders and the investment community. Finally, regulators, such as the FASB and SEC, may find the results to be of interest because they highlight an important use of new, mandated lease disclosures.

Cash Flow Trends and Their Fundamental Drivers: Comprehensive Review

Quarter 3, 2018

Free Cash Margin Index:

Recession Lows 0.99%, 3.45% (Dec. 2000, Dec. 2008) Current 4.01% (Sep. 2018) Recent High 6.88% (Dec. 2009)

January 2019

Median free cash margin declined slightly to 4.01% for the twelve months ending September 2018, compared to 4.04% for the twelve months ending June 2018 and 4.67% in September 2017. Median free cash margin has continued its downward trend, as the metric has declined every quarter since March 2017, and is now in-line with pre-and-post-recession norms. Consistent with an economic slow-down, median revenues have fallen slightly to $1,238.43 million in the September 2018 reporting period, marking four consecutives periods of falling revenues since the record high posted in December 2017. While these trends are disconcerting, revenues and free cash flow remain relatively high compared with historical levels.

Driving the decline in free cash margin was a reduction in median operating cushion, which fell to 14.29% in the September 2018 reporting period, compared to 14.35% in June 2018 and 14.37% in September 2017. This decline in median operating cushion was driven by a rather sharp increase in SG&A spending as a percentage of revenue, which climbed to 17.63% in September 2018, up from 16.99% in June 2018 and 17.59% in September 2017. A reduction in the cash cycle mitigated this period’s decline in free cash margin. The cash cycle fell to 48.81 revenue days in the September 2018 reporting period, down from 52.78 days reported in June 2018 and 51.48 days in September 2017. This decline in the cash cycle was driven primarily by a significant reduction in inventory days, which fell from 24.81 in September 2017 and 25.62 in June 2018 to a record low of 22.15 days in this most recent reporting period.

The continued stagnation of capital expenditures remains a concern. Median capital expenditures as a percentage of revenue fell to 3.58% in the September 2018 reporting period, down from 3.68% in June 2018 and 3.70% in September 2017. This metric has now either fallen or remained flat in every consecutive reporting period since September 2016. In fact, this 3.58% figure is the lowest in the dataset since the September 2011 reporting period. Tax payments continue to fall, as the percentage of income taxes to revenue declined to 0.55% in the September 2018 reporting period, compared to 0.68% in June 2018 and 1.33% in September 2017. Meanwhile, dividends and stock buybacks as a percent of revenue continue to climb, as they rose to 1.92% in September 2018, up from 1.90% in June 2018 and 1.41% in September 2017.

The recent tax reform bill was signed into law in December 2017 with the hope that lower corporate taxes would increase investment spending. However, capital expenditures have declined since then while dividends and stock buybacks have increased. While capital spending may still increase, to-date, it does not appear that tax reform is increasing long-term capital spending as was intended.



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Cash Flow Trends and Their Fundamental Drivers: Comprehensive Review

Quarter 2, 2018

Free Cash Margin Index:

Recession Lows 0.99%, 3.45% (Dec. 2000, Dec. 2008) Current 4.04% (Jun. 2018) Recent High 6.88% (Dec. 2009)

November 2018

Median free cash margin declined to 4.04% for the twelve months ending June 2018, compared with 4.17% for the twelve months ending March 2018 and 4.90% in June 2017. Median free cash margin has continued its downward trend, as the metric has declined in each of the last six reporting periods, but remains within pre-and-post-recession norms. Median revenues have fallen slightly to $1,268.80 million in the twelve months ending June 2018, and median cash and short-term investments have fallen to $145.83 million during this time as well. This marks the second consecutive period of falling revenues and cash balances. While these trends are disconcerting, revenues and free cash flow remain high relative to historical standards.

One factor driving the decline in free cash margin is an increase in the cash cycle, which ticked up to 52.78 revenue days in the twelve months ending June 2018, compared to 50.01 days from the previous reporting period. This increase in the cash cycle was driven primarily by an increase in median inventory days, which rose from 23.06 days for the March 2018 reporting period to 25.62 days in June 2018. Both days receivables and days payables increased slightly during this time. A modest reduction in median operating cushion also contributed to the decline in free cash margin. Median operating cushion for the June 2018 reporting period fell to 14.35% from 14.54% in the previous reporting period. This was driven by a reduction in median gross margin, which fell from 37.65% to 37.08% during this time.

A particularly concerning trend that may be emerging is a continued stagnation of capital expenditures. Median CapEx as a percentage of revenue fell to 3.68% in the June 2018 reporting period, down from 3.71% in March 2018. This metric has fall consistently since a post-recession peak of 4.02% in March 2016 and is currently at its lowest point since December 2011. For last year’s tax reform legislation to produce economic growth, increased corporate cash flows will need to be invested in capital projects.

Dividends and stock repurchases as a percentage of revenue rose to 1.90% in the June 2018 reporting period, up from 1.65% in March and up from 1.45% from June 2017. Median taxes paid as a percentage of revenue continued to fall, reaching a record low of 0.68% in June 2018, compared to 0.72% in March 2018 and 1.32% in June 2017. At this stage, it appears corporations are using their increased cash flows from lower taxes to pay dividends and repurchase stock rather than investing in capital expenditures that are more likely to generate economic growth.



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Cash Flow Trends and Their Fundamental Drivers: Comprehensive Review

Quarter 1, 2018

Free Cash Margin Index:

Recession Lows 0.99%, 3.45% (Dec. 2000, Dec. 2008) Current 4.17% (Mar. 2018) Recent High 6.88% (Dec. 2009)

August 2018

Median free cash margin decreased to 4.17% for the twelve months ended March 2018, compared with 4.59% for the twelve months ended December 2017 and 5.28% in March 2017. This metric has declined in each of the last five reporting periods, but is still aligned with pre- and post-recession norms. While median revenues declined slightly to $1,284.30 million in the March 2018 reporting period from the $1,320.15 million in the December 2017 reporting period, revenue growth is still intact as median revenues are up 13.46% year-over-year.



In the twelve months ended March 2018, gross margin before depreciation increased slightly to 37.65%, up from 37.61% from the December 2017 reporting period and up from 37.38% from the March 2017 reporting period. Selling, general, and administration spending before depreciation fell for the fourth consecutive quarter. Median SG&A as a percent of revenue was 17.17% in the March 2018 reporting period, compared to 17.26% in December 2017 and 18.38% in March 2017. The cash cycle fell from 52.16 days in the twelve months ended December 2017 to 50.01 days in the twelve months ended March 2018. This was driven by a decline in inventory days from 24.61days December 2017 to 23.06 days in March 2018 and an increase in payables days from 25.50 days to 26.37 days during this time. Receivables days increased slightly to 53.32 days in the March 2018 reporting period, up from 53.05 days in the December 2017 period. Due to tax reform, income taxes as a percentage of revenue continued to fall, reaching an all-time low of 0.72% for the March 2018 reporting period, following a previous all-time low of 0.80% for the December 2017 reporting period.



All else being equal, with lower corporate tax rates, one would generally higher levels of capital expenditures. That said, capital expenditures as a percentage of revenue was 3.71% for the twelve month period ended March 2018, which lags behind pre- and post-recession norms. Rather than using their tax cut windfall to invest in capital projects, firms are largely spending their money dividends and stock repurchases, which, as a percentage of revenue continued to climb, reaching 1.65% in the March 2018 reporting period, compared to 1.59% in the twelve months ended December 2017 and 1.55% in the twelve months ended March 2017.



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THE FREE CASH PROFILE: INSIGHT INTO THE CASH FLOW IMPLICATIONS OF GROWTH AN ANALYSIS USING 2017 DATA



June, 2018





As the U.S. economy continued its recovery in 2017 amidst the passage of the recent tax reform bill, companies enjoyed the benefits of revenue growth. In terms of cash flow generation, as revenues grow, there are certain industries and companies that will benefit more than others. It is a common misbelief that growth requires a use of cash. The reality is that there are many companies that actually generate increasing amounts of free cash flow as revenues grow. These companies have what we refer to here as a positive free cash profile.



The purpose of this study is to analyze the free cash profile of 20 non-financial industries, looking at all firms within those industries that have assets in excess of $100 million. Our goal is to identify those industries that can be expected to generate cash as revenues continue to grow, as well as those industries that will consume cash with growth. We also highlight specific industries to investigate factors underlying their free cash profile.



Overall, the median free cash profile for our sample is 5.98%, a notable increase from 2016’s median at 4.97%. There are 12 industries with a positive free cash profile, and 8 industries with a negative free cash profile. Industries with positive free cash profiles enjoy higher operating cushions and are more adept at managing operating working capital and limiting capital spending than industries with negative profiles. It is important to note that although industries have median positive (negative) free cash profiles, a number of companies within those industries may have negative (positive) free cash profiles.



Data for this research were provided by Compustat’s Capital IQ database.

Excel Spreadsheets of Cash Flow Data and Graphs by Industry

Quarter 3, 2019