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http://TheValueatRisk.blogspot.com
 
October
 
16,
 
2009
 
Investment
 
Capacity
 
Analysis
 
 –
 
Operating
 
Cash
 
Flow
 
to
 
Capital
 
Expenditures
 
Ratio
 
The price that an investor is willing to pay to acquire a share of a corporation's common equity islargely a function of the corporation's potential earnings growth. When purchasing a stock, youare effectively paying for earnings growth in advance of its actual occurrence. At a basic level, inorder to grow, a company must be able to invest in both its existing and future property, plantand equipment. A grading contractor who can barely afford the maintenance on his existingmachinery will most likely not be expanding the business any time soon. Therein lies theanalytical significance of the Operating Cash Flow (OCF) to Capital Expenditures (Capex) Ratio.
 
Once again, net cash flows provided by operating activities serves as the foundation of thisratio; because non-cash items on the income statement won't exactly help a company purchasea new tract of land or an excavator, we can go ahead an dismiss net income as irrelevant. Thepoint is to isolate the cash generated by a company's operations, and determine whether it isadequate to fund investment in its income producing assets. To calculate the ratio, simply go tothe statement of cash flows, and divide "Cash flow from operations" by "Capital Expenditures".A ratio greater than one (1) indicates that a company's operations are generating the cashnecessary to fund its annual investment needs. I'll use the cash flow rich Exxon (XOM) as anexample:
 
Operating Cash Flow to Capital Expenditures = Operating Cash Flow / Capital Expenditures= $59,725M / $19,318M= 3.09
 
http://TheValueatRisk.blogspot.com
 
October
 
16,
 
2009
 
During fiscal year 2008, Exxon generated over three times the cash needed from operations inorder to fund investment in its plant, property and equipment. The chart below compares theratio for several other companies.Clearly, some companies are more cash rich than others, and are better prepared to fundgrowth internally. A ratio of less than one (1) is indicative of a company that may need to borrowmoney, or that is in decline. I think we all know the story of Blockbuster (BBI); its ratio is so lowbecause it is in decline (to be fair, it is officially in decline from a brick and mortar video deliverystandpoint). OCF to Capex is definitely an important ratio that should be part of every investorstoolbox.
 
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