Michael Mauboussin: When Negative Free Cash Flow Makes Sense

In his latest interview with eToro, Michael Mauboussin discusses when negative free cash flow makes sense. Here’s an excerpt from the interview:

Mauboussin: The other thing that I would just underscore is that there have been and there will continue to be great businesses that have negative free cash flow.

And you might say oh that’s worrisome right, in other words their investments are larger than their earnings and as a consequence they have to continue to raise capital in the business.

That can be good or bad right, and it’s bad in the case where those investments have poor returns and hence the company is really struggling. It’s great if the economics of the investments are high and those investments are going to generate very high future cash flows right, so you’re basically… the future looks very bright.

The example I often like to cite is Walmart. For the first 15 years that Walmart was a public company it had negative negative free cash flow in each of those years.

Well that was great because the stores that they were building were very high return on capital stores, well above their opportunity cost.

So that capital was being used extremely productively and building value and of course the stock during that period I think nearly tripled the market’s performance. So it is about cash flow, negative cash flow is not by itself a bad thing, you have to decompose that to understand the economic returns.

You can watch the entire interview here: