FCF Yield

A useful metric for value and income investors

Free cash flow yield is important for any business as it acts as a measure of cash flow in comparison to the companys size. Cash flow is an important metric for a company, as it highlights operating performance. This is a useful metric for both income investors and value investors. The free cash flow yield metric can help investors decide if a stock is cheap or not and can also be used to identify good income-paying stocks on a cash flow basis. The free cash flow yield focuses on the cash a business generates rather than its profit or earnings.

The free cash flow yield can be calculated using the following formula:

FCF Yield (%) = FCF per share / Market Price per Share (MPS)

The FCF per share of a company is calculated by taking the free cash flow of the entity divided by the number of shares outstanding. The free cash flow of an entity can be calculated directly from the cash flow statement in the financials. Free cash flow is simply operating cash flow less capital expenditure.

The MPS is simply the price the share is currently trading at. Lets take a look at a simple example. Alphabet ($GOOG) had a FCF per share of $4.63 for the most recent final year (2021). The share is currently trading at $102.44. The free cash flow yield of Alphabet is thus:

4.63 / 102.44 = 0.0452

                      = 4.52%

High FCF Yield:

-         Implies a low price to FCF multiple (essentially the inverse of the FCF yield)

-         Annual cash flow is a high proportion of the firms equity value

-         Indicates that a stock is potentially undervalued

-         Expanding FCF yield is good

Low FCF Yield:

-         Implies a low price to FCF multiple

-         Annual cash flow is a low proportion of the firms equity value

-         Indicates a stock in potentially overvalued

-        Deteriorating FCF yield is a red flag

Assessing the FCF yield of a business for one period or quarter in isolation will not provide meaningful insights. Investors should assess the trend of the free cash flow yield over time and with similar companies in the same industry. A business is growing its free cash flow yield, this is a positive sign and indicates that the businesss operational performance is improving. A company with a growing FCF yield is also likely to have more cash on hand to pay dividends, repurchase shares, make capital investments or make acquisitions. It is also essential to compare the FCF yield of the business you are assessing to a company in a similar phase in the same industry. For example, if assessing the cash flow yield of a large established technology company like Microsoft it would not be appropriate to compare this to a start-up that is focused on growth and customer acquisition rather than cash generation.

In conclusion, the FCF yield is a useful metric for both value and income investors but should not be used in isolation but should rather be coupled with other fundamental measures.