Capital Expenditure (CAPEX)

Capital Expenditure (CAPEX) is the money a company spends to buy, maintain, or upgrade its long-term physical assets, such as property, buildings, technology, or equipment. Think of it as the company's spending on its heavy-duty toolkit. This figure is a big deal for value investing practitioners because it directly impacts a company's ability to generate cash. Unlike routine expenses on the Income Statement like salaries or marketing, CAPEX is an investment in the company's future productive capacity. You'll find this crucial number on the Cash Flow Statement, usually under “Investing Activities.” Understanding a company's CAPEX is like looking under the hood of a car; it tells you whether the owner is just paying for gas to get around town or is actually investing in a new engine to win races. A company that wisely manages its CAPEX can become a cash-generating machine, which is music to an investor's ears.

This is where the magic happens for analysts. CAPEX isn't just one number; it's a story with two main characters: maintenance CAPEX and growth CAPEX. Understanding this distinction is at the heart of calculating a company's true owner earnings, or Free Cash Flow (FCF). A company's FCF is essentially the cash from its operations minus its CAPEX. A high CAPEX number eats into the cash available for shareholders, but whether this is good or bad depends entirely on why the money is being spent.

• maintenance CAPEX: This is the recurring cost of just staying in business. It's the money spent to replace worn-out equipment and keep everything running smoothly, maintaining the current level of operations. This is a true cost to the business.
• growth CAPEX: This is the exciting part. This is discretionary spending on new assets to expand the business, enter new markets, or increase production. It's an investment in future profits.

A value investor's job is to figure out if a company's growth spending is generating a worthwhile return. If not, the company might be a “capital-guzzler” that endlessly consumes cash just to stand still or grow unprofitably.

No need to be a detective. Companies report their total CAPEX on the Cash Flow Statement. Look in the “Cash Flow from Investing Activities” section for a line item like “Purchase of property, plant, and equipment” (PP&E). Sometimes companies will net this against the sale of old assets, so you might need to look for the gross purchase amount to get the full picture.

A great first step is to compare CAPEX to the company's Depreciation and Amortization (D&A) expense, which you can find on the Income Statement or Cash Flow Statement. D&A is a non-cash charge that estimates how much an asset's value has been “used up” during a period.

• If CAPEX is consistently around the same level as D&A, the company is likely spending just enough to replace its wearing-out assets (i.e., mostly maintenance).
• If CAPEX is consistently higher than D&A, the company is investing for growth. The key question then becomes: is it getting a good return on that investment?
• If CAPEX is consistently lower than D&A, the company might be starving its business of necessary investment, which could lead to problems down the road.

Unfortunately, companies don't split out CAPEX into “maintenance” and “growth” for you. It takes a bit of educated guesswork. But understanding the concept is powerful.

Imagine you own a popular pizza shop. Your main oven, which has baked thousands of delicious pizzas, finally gives out. You spend $10,000 on a new, identical oven. This is maintenance CAPEX. You haven't increased your capacity to make more pizzas per hour; you've simply spent money to continue operating at the same level. From an investor's perspective, this $10,000 is a real cost of doing business, even though it's classified as an investment.

Now, imagine your pizza shop is so popular that there's a line out the door every night. You decide to buy a second oven for $10,000 to double your output and your sales. This is growth CAPEX. This spending is a choice, an investment made with the expectation of generating more profit in the future. A value investor wants to see that this $10,000 investment will produce a handsome return. Famous value investor Bruce Greenwald suggests a method to estimate maintenance CAPEX based on historical depreciation and asset growth, but for most investors, the key is to think critically about the nature of the business and its spending.

CAPEX is a window into the soul of a business. It reveals how capital-intensive the business is and how management is allocating owner's capital. Businesses with low CAPEX needs (e.g., software companies, consultancies, or brands like Coca-Cola) are often prized by investors. They can grow sales significantly without having to pour tons of money back into heavy machinery or infrastructure. This leaves more Free Cash Flow (FCF) to be returned to shareholders through dividends and buybacks or used for acquisitions. High-CAPEX businesses (e.g., manufacturers, utilities, or airlines) aren't necessarily bad investments. But they require a much closer look. For these companies, you must be confident that management is earning a high Return on Invested Capital (ROIC) on its massive investments. If not, the business could be destroying shareholder value, no matter how much its revenues grow.