Capital Expenditures (Capex)
Capital expenditures, usually shortened to capex, are the funds a company invests in long-lived assets: factories, machinery, data centers, store fit-outs, software infrastructure. Capex appears in the investing section of the cash flow statement rather than as an expense, because the cost is spread over years through depreciation.
The math
A company produces $150M of operating cash flow and spends $90M on capex, leaving $60M of free cash flow. The essential split is what that $90M buys.
If $70M merely maintains existing assets and $20M funds expansion, the business needs $70M every year just to stand still, so its true steady-state free cash flow is $80M. Suppose maintenance needs quietly climb to $110M as equipment ages: free cash flow turns negative by $20M at current spending, and a valuation built on the old $60M run rate, say 18x or $1.08B, rests on cash that no longer exists.
| Amount | |
|---|---|
| Operating cash flow | $150M |
| Maintenance capex | -$70M |
| Growth capex | -$20M |
| Reported free cash flow | $60M |
| Steady-state free cash flow | $80M |
The trap
Depreciation makes capital intensity easy to ignore. A company can under-invest for several years, report expanding margins and rising free cash flow, and reward the chart readers, right up until the deferred spending comes due all at once.
Buying a cheap-looking industrial at the top of that cycle means paying for earnings that the next capex wave will consume.
The move
Compare capex to depreciation over a full cycle: spending persistently below depreciation hints at under-investment, persistently above it demands proof of returns. Read management’s own split between maintenance and growth capex where disclosed, and test it against asset age.
Then ask the only question that matters for compounding: what return does each incremental dollar of capex earn? A business that reinvests at high returns deserves its multiple; one that spends heavily to stay in place does not.