FCFE

CFA Level II Equities
#1

Hi,

Can someone please explain what is the meaning of the following two statements?

  • the company is dividend paying but exceed or fall short of FCFE.
  • The company’s free cash flows align with the company’s profitability within a forecast horizon with which the analyst is comfortable.

Thanks.

#2

Point 1

FCFE is the cash flow available for equity shareholders. So, if dividends are exceeding FCFE, management is: (1) or paying too much dividends via more debt, (2) or FCFE has worsen and dividend policy statement must be updated in order to pay less dividends.

Point 2

The regular operations of a business must lay a profitability margin, the more stable, the better. It also depends on industry though. For example, retail business requires stability in monthly or even weekly profitability margins. Construction business requires margin stability for longer periods, say quarterly or even annually because construction cash outs and cash ins are not always joint.

Cash flows not only consider Cash From Operating Activities, but also extraordinary cash inflows and outflows, so the analyst statement about she is comfortable with cash flows and company’s profitability in the analyzed horizon would mean that inside the most suitable horizon timeframe for evaluating such business, the cash flows are correctly aligned with profitability margins (which is good).

Hope this helps

#3

A subtle point: if you issue more debt to pay the dividends, FCFE increases, so the dividends _ don’t _ exceed FCFE.

#4

Thank you Harrogath and S2000magician.

#5

My pleasure.