The Relationship Between Free Cash Flow and Share Prices of The Mining Sector in South Africa

This study examines the relationship between the free cash flow (FCF) and stock price (SP) particularly of the mining sector in South Africa (S.A). According to Van Zyl (2014), the independent variable looks at two or more levels that can be influenced to get the results of the specific study. The free cash flow and the stock price are considered to be the independent variables relating to this study. Dependent variable indicates the degree to which the outcome of a study is reflected, therefore the mining sector is considered the dependent variable of this study.

Maksy (2013) conducted a study enlightening that cash flow from operations less capital expenditures is most connected with stock prices. The author emphasized the importance of the company to disclose their FCF using this definition, as the author believes this should assist the investors in making wise decisions. Disclosure of the firm’s free cash flow differently can affect the division of risk sharing between internal and external investors regarding the stock price added. Vedd and Yassisnski (2015) agreed that among others operating cash flows can influence the stock price for companies in Latin America and the study looked at more than half a thousand of publicly traded companies in Latin America which are considered being one of the biggest stock exchange market.

Most authors define cash flow and stock price differently. According to the accounting tools.com, defines cash flow “as the net amount of cash that an entity receives and disburses during a period of time” and Maksy (2013) stated that "different authors, academic articles, textbooks, and companies define free cash flow according to their specifications and defining Free Cash Flow as cash flow in excess, also quoted Mandalay Resort from changing their FCF definition from Operating Income in 1988 and from 2000 added back pre-opening expenses, abandonment loss, depreciation and amortization, interest, dividend and other income”.

A stock price is the amount of capital paid into a business by investors cited from the accounting tool.com, on the other hand, Ibrahim (2008) argued that “stock prices represent discounted present values of firm’s expected future cash flows or profits”. Mexico and Latin America have growing economies and their publicly traded companies attract investors across the world result in an increase of a stock price. The researchers determined that accounting information can help determine the company’s overall financial position, also added that based on their analysis amongst with cash flow from operating activities do have an effect on return cited.

According to Vedd and Yassinski (2015) has enlighten that the work of authors Eugene, Fama, and Kenneth in 1995 studied the relationship between the book to market equity and the firm size whether or not how it affected earnings and stock prices and the outcome shown that firm size and book to market equity are related to profitability. The evidence gathered by the authors agreed to the thesis that firms with low stock price tend to have less profitable and have less earnings or free cash flow, this can be calculated using the flowing financial accounting formula

Stock value = (Free Cash Flow)/((1+WACC))

WACC stands for weighted average cost of capital

“Analysts took a conscious decision to use a particular type of valuation model to derive to a target price for a particular stock, use of particular type of model reflects a deliberate decision by the analyst to focus on certain aspects while performing analysis". Lehavy and Sloan (2008) indicated that the stock price is increasing due to the degree of the investor's recognition, the more investors know about the securities the more they optimize their portfolios increasing the stock price. However the less they know about a particular security, their only way for the market to clear is for these investors take large undiversified positions in the security resulting in these investors to require higher expected returns to compensate them for the increased distinctive risk. The latter exercise should push down the stock price attracting more investors. Demand and supply play a vital role in the stock price movement.

Previous studies overlooked the factors relating to the connection between the stock price and free cash flow in the mining sector. External factors can strongly affect the movement of the stock price in the mining sector. A mining firm should be aware of the labor laws of the country it operates in and well and the cultural diversity more especially in South Africa. The mining sector in S.A has a high number of homestead workings coming from all provinces. Mining firm operating in S.A should familiarize its self with labor unions hence this sector has a high rate of the strike which can last longer than five months or more. In 2014 a platinum sector had a huge labor strike, the dispute regarding wages and conditions of service between the Association of Mineworkers and construction union and the main platinum producers which cost the mining revenue of approximately R23 billion. The platinum sector during that transaction the stock price drop drastically cited Bohlmann, Dixon, Rimmer, and Van Heerden 2014.