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The SunEdison Story: A Few Takeaways

Summary

SunEdison has been running towards the cliff for a while. It finally reached the end.

The red flags were seen from a distance: many people just did not pay attention to them for some reason.

I provide a few technical and non-technical recommendations, which, in my opinion, will increase investors' chance of making rational investments in the future.

Learn your lessons from other people's mistakes.

Recently, I received a message from a person, who lost $4,500 on SunEdison's (NYSE:SUNE) shares. He saw a few of my articles on the stock's options, which I recommended buying or selling at different time periods since December 2015, when I first wrote about the company. He wondered whether the options could help him offset some of the losses.

The truth is, one cannot do anything about SunEdison's bankruptcy at this point in time. Even options cannot save him now. However, you can learn something from this example. A lot, in fact.

Today, I would like to point out a few recommendations from financial analysis for investors buying stocks (and bonds) in the future:

(1) It is best when a company generates free cash flows (calculated as operating cash flows less capital expenditures, for simplicity). When a company generates free cash flows, it can distribute cash in the form of dividends or buybacks. It can also use the money to finance its own growth, remaining independent of capital markets. It is a rule of thumb that a company is considered healthy when it consistently generates free cash flows;

(2) If the company does not generate free cash flows, make sure it at least has growing operating cash flows from year-to-year (this is why the Cash Flow Statement is paramount to financial analysts). SunEdison not only failed to grow operating cash flows but it had negative cash flows from operations. They were not only negative: they were becoming more negative year-over-year.

When the company has negative operating cash flows, it basically means that investors are paying their own money to keep they company's doors open. In other words, the company is burning cash in daily activities.

Therefore, the company is practically better off closing down the operations. If the company is doing this consistently and raises cash in the form of debt or equity to finance its daily operations, why would you want to own it in the first place?

(3) Analyze operating cash flows: make sure that earnings make up at least half of total operating cash flows. My suggestion is to look at companies that have at least 60%-70% of operating cash flows in earnings.

Remember that adjustments for non-cash items or changes in working capital can add a lot of cash to total operating cash flows. You have to make sure that most operating cash flows come from the company's commercial activities, not timing differences or other advantages (e.g. D&A benefits);

(4) Capital expenditures must drive sales in the long-run. It is easy to analyze that by dividing total capital expenditures by total sales (you can also divide historical CapEx by current sales to see what the trend is). Ideally, this proportion should remain roughly the same.

(5) Check debt ratios: they should stay in line with the industry over a considerable amount of time. If you want to be more conservative, choose industries that do not have high leverage. SunEdison...


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