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If you are currently a shareholder in Tencent Holdings Limited (HKG:700), or considering investing in the stock, you need to examine how the business generates cash, and how it is reinvested. What is left after investment, determines the value of the stock since this cash flow technically belongs to investors of the company. I’ve analysed below, the health and outlook of 700’s cash flow, which will help you understand the stock from a cash standpoint. Cash is an important concept to grasp as an investor, as it directly impacts the value of your shares and the future growth potential of your portfolio.
View our latest analysis for Tencent Holdings
What is free cash flow?
Tencent Holdings 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.
I will be analysing Tencent Holdings’s FCF by looking at its FCF yield and its operating cash flow growth. The yield will tell us whether the stock is generating enough cash to compensate for the risk investors take on by holding a single stock, which I will compare to the market index. The growth will proxy for sustainability levels of this cash generation.
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
Tencent Holdings’s yield of 1.74% indicates its sub-standard capacity to generate cash, compared to the stock market index as a whole, accounting for the size differential. This means investors are taking on more concentrated risk on Tencent Holdings but are not being adequately rewarded for doing so.
Does Tencent Holdings have a favourable cash flow trend?
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 700’s expected operating cash flows. Over the next few years, the company is expected to grow its cash from operations at a double-digit rate of 73.4%, ramping up from its current levels of CN¥100.46b to CN¥174.25b in two years’ time. Although this seems impressive, breaking down into year-on-year growth rates, 700’s operating cash flow growth is expected to decline from a rate of 41.6% next year, to 22.5% in the following year. But the overall future outlook seems buoyant if 700 can maintain its levels of capital expenditure as well.
Next Steps:
The company’s low yield relative to the market index means you are taking on more risk holding the single-stock Tencent Holdings as opposed to the diversified market portfolio, and being compensated for less. Though the high operating cash flow growth in the future could change this. Keep in mind that cash is only one aspect of investment analysis and there are other important fundamentals to assess. You should continue to research Tencent Holdings to get a more holistic view of the company by looking at: