📖Peter Lynch

Free Cash Flow

🌿 Intermediate★★★★☆

Free cash flow reveals whether a company actually generates real money or just reports accounting profits.

💬

Cash flow is the lifeblood of a company.

— *One Up On Wall Street*，1989

🏠 Everyday Analogy

Just as assessing a person's health requires more than observing a rosy complexion (accounting profit), one must also check the pulse to evaluate blood circulation (cash flow). A complexion can be enhanced with makeup, but the strength of blood circulation directly determines how long and how far a person can endure.

📖 Core Interpretation

Free cash flow provides a more accurate reflection of a company's true profitability than accounting profits.
💎 Key Insight：Earnings can be manipulated through accounting tricks, but cash flow is harder to fake. Lynch looks at free cash flow — the money left after capital expenditures — as the truest measure of financial health. A company that consistently generates strong free cash flow can pay dividends, buy back shares, reduce debt, and fund growth. Reported earnings without cash flow are a red flag.

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❓ Why It Matters

Profits can be manipulated, while cash flow is difficult to fabricate.

🎯 How to Practice

Focus on operating cash flow and free cash flow, comparing them with net profit.

🎙️ Master's Voice

All you need for a lifetime of successful investing is a few big winners.
Lynch's portfolio returns were driven by a few huge winners. Most stocks did okay; a few did spectacularly. Finding and holding big winners mattered most.

⚔️ Practical Guide

✅ Decision Checklist

  • Am I holding my big winners?
  • Am I selling winners too early?
  • Do I have potential big winners?

📋 Action Steps

  1. Hold big winners for years
  2. Seek companies with 10-bagger potential
  3. Let winners run

🚨 Warning Signs

  • Selling winners early
  • No big winner potential
  • Cutting flowers

⚠️ Common Pitfalls

✕High-growth companies may experience negative cash flow in the short term.
✕Distinguish between the investment phase and the maturity phase.

📚 Case Studies

1
Dunkin’ Donuts Turnaround (1982)
Lynch bought shares when Dunkin’ Donuts traded at a low P/E, strong free cash flow, and steady franchise royalties despite recession fears.
✨ Outcome：Stock multiplied several times over the decade as cash flows grew, validating free cash flow as a key value metric.
2
Fannie Mae Cash Flow Story (1980)
Lynch invested when Fannie Mae was distressed but generating strong and improving free cash flow from its mortgage portfolio.
✨ Outcome：Position became one of Magellan’s big winners as earnings and free cash flow surged, leading to substantial multi‑bagger returns.

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