Why is Free Cash Flow preferred in DCF analysis over Earnings?

Free Cash Flow (FCF) is preferred in Discounted Cash Flow (DCF) analysis primarily because it represents the cash that is actually available to be distributed to investors, including equity and debt holders. While earnings may indicate profitability, they can be significantly influenced by non-cash items such as depreciation, amortization, and various accounting adjustments that might not accurately reflect the cash-generating ability of the business.

In contrast, Free Cash Flow focuses on the cash that a company generates from its operations after accounting for capital expenditures. This core measure gives a clearer, more straightforward view of the financial health and operational efficiency of a business. By using FCF in DCF analysis, investors can better understand the real cash flows that can be utilized for dividends, share buybacks, debt repayment, or reinvestment in the company, providing a more reliable foundation for valuation than earnings alone.

In summary, Free Cash Flow's representation of cash available to investors makes it a more relevant metric in assessing a company's intrinsic value in DCF analysis.