Capital expenditures (CapEx): Investing for long-term growth

Open full sized image

Whether it’s a factory, data center, or new equipment, CapEx is an investment in a company’s future.

© Andy Dean/stock.adobe.com; Photo illustration Encyclopædia Britannica, Inc.

Capital expenditures, or CapEx, are cash outlays that a company makes to acquire, build, or improve long-lived assets. These expenditures are most commonly associated with property, plant, and equipment (PP&E)—a category that includes land, buildings, machinery, and tools—but can also include certain software and technology investments.

CapEx is generally recorded as an asset on the balance sheet and recognized gradually on the income statement through depreciation or amortization. This accounting treatment sets it apart from operating expenses (OpEx), which reflect the ongoing costs of running a business.

CapEx is an indicator of how much a company is investing in its long-term operations and future capacity. It’s also an important indicator for investors because it directly affects a company’s cash flow.

Analysts generally divide capital expenditures into two categories:

Businesses spend money continually. Each expenditure must be classified as either OpEx or CapEx, depending on how long the business expects to benefit from it. For example, buying gas is an OpEx because it lasts only a few hours or days. Buying a new gas tank is a CapEx because it lasts for years. In general, expenditures expected to provide benefits beyond one year are capitalized rather than expensed immediately.

CapEx is vital to a company’s development and long-term prospects. Choosing how and where to devote CapEx is important for several reasons.

Capital expenditures are long-term decisions. CapEx, by definition, is an investment with ramifications for the future capabilities of the company. At companies both large and small, CapEx is the product of long-term strategic goals, as well as extensive planning and budgeting.

CapEx decisions are also very difficult to reverse without incurring losses for the company. For example, if artificial intelligence turns out to be an expensive and energy-intensive technology incapable of delivering meaningful breakthroughs or cost savings, a company that spent billions on specialized data centers could be forced to reduce—or write down—the value of those assets. Some capital assets, such as aircraft, railcars, ships, construction equipment, and industrial machinery, have active secondary markets. But companies rarely recover their full investment, particularly when an asset was built or purchased for a highly specific purpose.

At the same time, CapEx for most companies is costly. And although these investments may deliver a return in the long term, the initial outlay can be very high when you consider assets like buildings, equipment, or property.

During their useful life, the assets purchased with CapEx almost always depreciate, or lose value. So although they do add to the assets on the company balance sheet at first, that amount will fall over time as depreciation is periodically recorded as an expense.

Although CapEx doesn’t show up on a company’s income statement, it directly affects a company’s free cash flow, considered one of the most important measures in corporate finance. Because free cash flow represents cash remaining after a company funds its operations and capital expenditures, it’s a key metric for investors.

The way investors view CapEx varies. A company whose high maintenance CapEx restricts its free cash flow may look different from a company with equally low cash flow, but that has been dedicating new income to growth CapEx.

In some cases, heavy CapEx is exactly what investors want to see. A company that’s building AI data centers, opening new production facilities, or investing in breakthrough medical treatments may be spending heavily today because management believes those investments will drive future growth. The challenge for investors is deciding whether those expenditures are laying the foundation for tomorrow’s success—or simply consuming cash.

There are different kinds of CapEx—maintenance and growth CapEx. Investors often view capital spending through different lenses, just as there are different kinds of stocks to invest in—growth stocks and value stocks.

Value-oriented investors may prefer companies with stable earnings, strong free cash flow, and a history of paying dividends, often accompanied by moderate CapEx spending. Growth-oriented investors, on the other hand, may be more willing to accept heavy CapEx if they believe those investments will drive future revenue and earnings growth.

CapEx is an important item on the balance sheet, but it doesn’t exist in a vacuum. Just as important as the amount spent is what a company is spending it on, and how likely those investments are to generate long-term value.