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Topics Covered
- Operating cash flow (OCF)
- Income statement
- Statement of cash flows
- Initial public offering (IPO)
Talk Citation
McDonald, M. (2024, July 31). Snowflake: free cash flow vs. GAAP net income [Video file]. In The Business & Management Collection, Henry Stewart Talks. Retrieved October 16, 2024, from https://doi.org/10.69645/ENTA4233.Export Citation (RIS)
Publication History
Extended-form Case Study
Snowflake: free cash flow vs. GAAP net income
Published on July 31, 2024
14 min
Transcript
Please wait while the transcript is being prepared...
0:00
Hello, I'm Professor
Michael McDonald.
I'm a professor of finance at
Fairfield University in
Fairfield Connecticut.
Today, I'd like to talk
to you about one of
the most interesting
corporate stories
in the last few years,
and that is Snowflake.
Now you may or may not be
familiar with Snowflake,
but it's a software company.
And what we're going to look
at today is the dichotomy
between free cash flows
and GAAP net income.
0:30
Now, there's a
variety of firms out
there that trade in
the stock market.
Many of those firms
have long histories and
might be solidly
profitable but with
relatively low growth
prospects over time.
In contrast, there are numerous
publicly traded
companies that have
either minimal or no
accounting profit at all,
either under the
US GAAP standards
or the international
IFRS standards.
That's very common to see.
We could name many
technology companies,
software companies,
and things like that.
Yet these firms are oftentimes
commanding very
high stock prices;
Shopify, Uber, HubSpot,
Spotify, Salesforce, Snowflake.
They're all examples of this.
So that begs an
important question.
Why do these firms have
positive share prices,
oftentimes very
high share prices,
and substantial market
capitalizations,
if they're not
earning any profit?
The basic foundation
of finance tells us
the value of a stock is,
in the most simple
form, V = D1/(K-g).
Something we all see from
the first finance class we take.
The value of the company
is equal to dividends for
the upcoming year divided by
the cost of capital
minus the growth rate.
Conventional finance then tells
us if a firm doesn't have
any dividends this year,
next year or on the horizon,
we really can't
make an intelligent
valuation about the firm.
We have to do something
very speculative.
So why is it that these firms
have very high stock prices?
This is often confounding
to university students
that I'm teaching.
The answer to the question is
that investors are expecting
long-term high levels of growth
so the current earnings
don't matter much.
And that's a pretty
straightforward concept.
Most people
understand that, hey,
even if this firm isn't
generating profits right now,
we think that over
the next 10 years,
they're going to grow markedly
and they'll have big
profits going forward.
So, certainly,
that's one answer.
But there's another answer
which is more subtle,
but arguably more important.
Earnings, as we report them,
under either GAAP or IFRS,
are accounting earnings.
That may or may not capture
what investors actually care
about, which is cash flow.
I don't care at all about
Snowflake's accounting earnings.
If they have positive GAAP
income, that's great.
If they have negative GAAP
income, that's fine too.
I don't care.
What I actually care about
is the level of cash flows
produced by the company and
hence by my investment.
That's what investors
are looking for.
They're looking
for a cash return,
a financial return,
on their investment.
And how do they get
that financial return?
Through the generation of cash.
Accounting earnings are just
numbers on a piece of paper.
Cash earnings are what
actually goes into
the bank account and
ultimately can get paid
out to shareholders or used
to grow the company further.