Worksheet: Direct cash flow
Probably implausible
This note is part of the Pier Review reference material.
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Overview
After the fact that Pier Analysis provides subscribers with the spreadsheet models underpinning its thinking, the most distinctive feature of Pier Analysis's approach is its belief that cash flows should be presented directly.
Companies normally use an indirect layout for the statement of cash flows that they set out in their published accounts. This is harder to understand, and leaves out information that is essential to reaching an informed opinion about how a business is doing.
The worksheet Direct cash flow is where the model sets out the direct cash flow for the business under consideration.
Layout
The worksheet Direct cash flow has three functions.
At the left side, it shows the cash flow generated by the business over the last five years.
In the middle, it shows the same cash flows, but adjusts them to exclude items that are unlikely to recur. The idea is to get some sense of the underlying cash flow that the company ought to be capable of repeating in future years.
To the right, it shows a projection of cash flows in future years.
It is an intentional feature of Pier Analysis that its approach is different from most company research. Two of those differences are prominent on this worksheet.
The cash flows are shown in direct form, something Pier Analysis believes is indispensible to truly understanding a business’s performance. The accounts of nearly every company present them in an indirect layout, which is much harder to understand or discern trends in, and Pier Analysis goes to some trouble to recast them in direct form.
The projections for future years are almost certainly implausible, and deliberately so.
The usual method for valuing a company is to make projections of future cash flows that are as plausible as one can manage; to discount them to derive a present value; and to compare that present value with the current market value. If the present value is higher, one might buy shares in the company. If the market value is higher, one might sell them. Forecasting the cash flows accurately is somewhere between difficult and impossible.
Pier Analysis does none of this. Its projections of future cash flows are derived from the valuation, and are consequences of assumptions about how long you are willing to wait to get your money back, at what rate you want to be rewarded while you wait. They are mathematical inevitabilities and demand no judgement. It is then left to the reader to decide if there is any chance that the business could generate those cash flows. They will often be quite implausible, and this is actually very welcome, as it allows companies to be dismissed as candidates for consideration and attention to be turned to alternatives.
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