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FCF yield: free cash flow measured against the share price

Definition of the FCF yield (free cash flow yield), its formula, where to find FCF in an annual report, usual thresholds by profile, traps of unusual years and sectors excluded.

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Definition

FCF yield divides annual free cash flow (FCF) by market capitalization. It shows what share of its stock market value the company generates in cash each year, once its investments are paid for. It is the money available to pay dividends, repurchase shares, pay down debt or make acquisitions.

Formula

FCF yield = (operating cash flow − capital spending) / market capitalization

Where to find it in an annual report

Operating cash flow and capital spending (purchases of property, plant, equipment and intangible assets) are in the cash flow statement. Market capitalization is the share price multiplied by the number of shares outstanding, excluding treasury shares.

Common thresholds

Value: 7% or more for green, from 4 to 7% for orange, red below 4%. Quality or fast-growing companies often show an FCF yield of 2 to 4%, which their growth has to make up for. An FCF yield above government bond yields is a frequently quoted benchmark.

In the preset strategies

Preset strategy Criterion met To monitor Criterion not met
Value FCF yield ≥ 7% 4% to 7% < 4%

Pitfalls

  • FCF for a given year can be inflated by a one-off fall in inventory or postponed investment: look at the average over several years.
  • FCF yield ignores debt: a heavily indebted company can show a high yield while its FCF goes first to its lenders. Dividing FCF by enterprise value corrects this bias.
  • Stock-based pay does not come out of cash, but it dilutes shareholders: some analysts subtract it from FCF.
  • Depending on the source, leases (IFRS 16) and acquisitions are treated differently in FCF.

Where it does not apply

  • Banks and insurers: FCF makes no sense there.
  • Companies in a heavy investment phase, with negative or zero FCF: the ratio says nothing about their future profitability.

A worked example

A fictitious company, called Company AB here, generates €84 million of FCF for a market capitalization of €1.2 billion. Its FCF yield is 84 / 1,200 = 7%: green for the Value preset strategy.

FCF yield and P/E

A P/E of 15 corresponds to an earnings yield of 6.7%. If the same company’s FCF yield is only 3%, only half of its earnings turn into cash. The FCF conversion entry explains this gap. See also price to FCF, which says the same thing the other way round.

Sources