June 28, 2024

Stock Prices Always Follow Free Cash Flow Per Share Over Time

Authored by Louis Stevens

"Our ultimate financial measure, and the one we most want to drive over the long-term, is free cash flow per share.

Why not focus first and foremost, as many do, on earnings, earnings per share or earnings growth? The simple answer is that earnings don’t directly translate into cash flows, and shares are worth only the present value of their future cash flows, not the present value of their future earnings."

-Jeff Bezos, Founder, Former CEO, and Executive Chairman of Amazon, 2004 Amazon Shareholder Letter

In making this statement, Mr. Bezos was sharing commentary on the underlying math of reality, defined by physics, energy, and basic laws of our universe. Because money = energy, stock prices are essentially energy management systems that can be concretely understood mathematically. That does not mean that they can be predicted with perfect certainty, as the future is inherently uncertain, and markets are often governed by emotions like fear and greed in the near term; however, stocks and bonds are a matter of definitive, physics-based energy management, and fashioning a stock in such a way that we know its actual cash, or money (i.e., energy), generation gives us a concrete understanding of the business today.

  • Free cash flow = the amount of cash that a business generates after paying all expenses and reinvesting in its business for future growth.

This is what Mr. Bezos meant in his remarks above.

In recent months, I've shared charts on L.A. Stevens' X account in which I included stock prices and the free cash flow per share generated by the businesses associated with those stock prices. In doing so, I've implicitly communicated the ideas above.

Here are a few examples, along with the attached message that I've shared for each chart within my posts on X.

Stocks Prices Always Follow Free Cash Flow Per Share Over Time, Amazon

Stock Prices Always Follow Free Cash Flow Per Share Over Time, Meta

Stock Prices Always Follow Free Cash Flow Per Share Over Time, Snowflake

  • Sometimes, the market trades a company's shares in the opposite direction of its free cash flow per share trajectory. This can represent an exceptional opportunity to generate solid returns via an asymmetric risk/return setup where risk is dwarfed by prospective returns.

Stock Prices Always Follow Free Cash Flow Per Share Over Time, Hims & Hers Health

  • I originally shared this chart when Hims was about $6/share in late 2023, and my point was that, eventually, the stock price would follow its free cash flow per share generation. As with the previous example using Snowflake, there are many instances in which the market trades a stock in an irrational manner, i.e., the stock price trends in a direction opposite of its free cash flow per share trajectory.

And, as many of you know, free cash flow per share is the first variable in the equation of equity value, which includes four variables in total:

  1. Free cash flow per share amount
  2. The growth of free cash flow per share
  3. The durability of free cash flow per share
  4. An investor's next best alternative, and, in the case of public equities, this is the risk free rate, i.e., the 2 year or 10 year treasury bond, against which a company's free cash flow yield (free cash flow per share/stock price) is measured and compared

Ultimately, these four variables are necessary for fashioning a stock into a bond in such a way that 1) investors can understand the actual cash (energy) they will receive, or theoretically receive, via ownership of said stock and 2) investors can compare this cash yield, or prospective cash return, against risk free alternatives, or just alternatives in general for those who may invest in real estate or other asset classes.

This process is, in some sense, the divine process of the God-mind of the market.

The market can be thought of as an intelligence that is constantly employing this four variable equation to identify the price at which stocks should trade.

It is managing energy: it's constantly divining how much energy (money) will be dispensed by one security (stock or bond) or another, thereby setting the price of those securities in a constant, evolving dance.

Now, one of the unique elements of this energy management system is that it's sometimes not driven totally by the "laws of money," detailed above. Sometimes, it's driven by pure human emotion, such as fear, which causes stock price collapses, and greed, which causes stock prices to soar to heights where their cash yield becomes so de minimis that the God-mind of the market eventually yanks the stock price back to earth so as to bring it into equilibrium with the comparative analysis with its risk free bond counterparts that I cited above.


L.A. Stevens has rated Meta and Hims & Hers Health "Buys."

L.A. Stevens has provided no ratings for Snowflake and Amazon.

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