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However, when it does, the company's deferred revenue and cash holdings go up, and the change in deferred revenue shows up in operating cash flow.
FREE PROPERTY EVALUATOR CASH FLOW SOFTWARE
Software businesses that operate on a subscription basis often collect a contract's worth of cash up front, whether it be a year, two years, or whatever the term is.
FREE PROPERTY EVALUATOR CASH FLOW FREE
The second way free cash flow distorts real owners' earnings at software companies is deferred revenue. That's a $425 million discrepancy, and it makes a big difference when trying to value the company. Great, right? Well, investors have to square that with the company's GAAP net loss of $73.2 million. Last quarter, Palo Alto's adjusted free cash flow was $351 million on $1.39 billion in revenue, good for a 25.3% free cash flow margin. While I applaud Palo Alto for its product execution, investors should probably ignore the high adjusted ( non-GAAP) free cash flow margin that management touts in company presentations. The company has managed to continue strong revenue growth, even matching the newest disruptors in this fast-evolving space. Management has done an excellent job of transitioning its legacy on-premises firewall business to more modern cloud and software-based threat detection solutions. Let's take cybersecurity company Palo Alto Networks ( PANW -1.99%) as an example.įirst, Palo Alto is a great cybersecurity company. Here's an example of what I'm talking about, and it's something every investor in the software space needs to recognize. Unsurprisingly, many technology CEOs often point to their free cash flow generation, when in fact the real earnings going to shareholders is far lower. In fact, free cash flow often looks better than headline earnings in software, and deceptively so.
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Yet while free cash flow may be the conservative metric to use in, say, a manufacturing business, in the world of software, free cash flow can be really, really misleading. When that happens, the amount of cash left over for shareholders after these investments may be lower than what headline earnings would suggest. That's because a company's cash capital expenditures and working capital investments often exceed non-cash depreciation, either because of growth or merely inflation. With inflation and interest rates on the rise, investors are paying more attention than ever to intrinsic value, rather than just revenue growth and momentum that we've seen over the past few years.ĭyed-in-the-wool value investors generally point to free cash flow as the "holy grail" metric by which to value a stock.