CapEx, or capital expenditure, is the amount of money a company invests in itself to secure a profitable future. For example, telecommunications giants, like Verizon and AT&T, are investing heavily in wireless network infrastructure to support the rollout of 5G. The CapEx ratio is a measure used by investors to assess the future prospects of a company. The ratio shows how comfortably a company can finance its capital expenditures after paying for its operating activity and issuing dividends to shareholders.
Key Takeaways: CapEx, or capital expenditure, is the amount of money a company spends to secure future profitability.
The CapEx ratio is a measure used by investors to assess the future prospects of a company.
The ratio shows how comfortably a company can finance its capital expenditures after paying for its operating activity and issuing dividends to shareholders.
Companies with high CapEx spend liberally on innovation and infrastructure after they have paid for operational expenses and distributed dividends to shareholders.
Understanding Capital Expenditure (CapEx) and the CAPEX Ratio
CapEx can be used to encourage growth or boost productivity. A company that uses CapEx for production will have higher annual maintenance costs but will likely have a lower valuation than a company that does not have such high annual maintenance costs.
Such a company, however, can use its CapEx to increase revenue and productivity. Regardless of how CapEx is used, it is reported as expenditures on the income statement and calculated as a percentage of annual revenue that may reduce profit and negatively affect the company's valuation.
Calculating the Capital Expenditure (CapEx) Ratio
The formula for calculating the CAPEX ratio is the following:
CAPEX Ratio = Operating Cash Flow / Capital Expenditures
If the company makes payments to the equity holders in the form of dividends, these payments are a priority. Therefore, the amount of operating cash flow is adjusted for the number of dividends and then compared to the amount of CapEx.
CAPEX Ratio = (Operating Cash Flow – Dividends) / Capital expenditures
Interpreting the Capital Expenditure (CapEx) Ratio
If the value of the indicator exceeds 1, this indicates that the company has sufficient funds to finance its own development. If the value is lower than 1, the company needs additional funds from external sources of financing to implement active investment programs in the future.
Companies with High Capital Expenditures
Five companies with high CapEx are Alphabet, AT&T, Amazon.com, Verizon Communications, and Microsoft.
In 2018, Alphabet reported that Google’s capital expenditures, which include the costs of data centers and other facilities, more than doubled in 2018, which was the fastest expansion in at least four years. CapEx was just over $25 billion. According to CSI Market, the company's average capital expenditure ratio is 49.5%. According to Ruth Porat, CFO, Alphabet expected its growth in capital expenditures to slow in 2019, and the COVID-19 epidemic will no doubt have had a dampening effect on the company's investments. However, according to SDxCentral, Google and Alphabet CEO Sundar Pichai suggested that the company would invest more than $10 billion in 2020 into offices and data centers in the United States.
In October 2020, according to ZDNet.com, AT&T reported that it expected gross capital investment of around $20 billion in 2020, most of it tied to the deployment of the 5G network In 2019. For the fourth quarter of 2019, the company reported a capital allocation of 50% to 70% of free cash flow post-dividends for retiring 70% of shares issued for its Time Warner deal.
Amazon.com's 12-month capital expenditures for 2019 was almost $32 billion. According to The Information, Amazon could reach CapEx of over $31 billion for 2020. According to The Information, "Amazon has ratcheted up spending on CapEx this year so fast that it now outspends all other big tech firms, including the previous CapEx leader, Alphabet."
In October 2020, Verizon stated that it expected its capital spending, or CapEx, to be between $17.5 billion to $18.5 billion for 2020 as it worked to build its 4G LTE network, launch and expand its 5G networks, and upgrade its existing network architecture. In 2019, Verizon Verizon spent $17.9 billion on CapEx in 2019.
From fiscal year 2016 to fiscal year 2020, Microsoft's capital expenditures have steadily increased from $8.9 billion to $19 billion. Most of that expenditure has been on data center expansion as Microsoft competes with the other leading cloud providers Amazon and Google. According to Cisco, by 2021, 94% of workloads are expected to be processed in cloud data centers, which explains why these three companies are investing billions of dollars in capital expenditures in the cloud space.
For many companies, particularly technology leaders, heavy capital investment is necessary to keep up with industry advancements and to ensure their sustainability and market dominance. These companies must have the capital available to spend on innovation and infrastructure as well as be able to pay for their operations and distribute dividends to shareholders.