FCF Yield

FCF Yield is a financial metric that measures a company's annual Free Cash Flow (FCF) per share relative to its share price. Think of it as the inverse of the Price-to-FCF ratio. For value investors, this is one of the most honest and powerful valuation tools in the shed. Why? Because while profits reported in financial statements can be massaged with accounting choices, FCF represents the actual, cold, hard cash the business generated after paying for its operations and reinvesting for the future. It's the real cash surplus that the company could, in theory, hand over to its owners (the shareholders) at the end of the year. A high FCF Yield suggests that you are paying a low price for a company's cash-generating power, which is the very essence of a bargain. It's a direct answer to the question: “For the price I'm paying, how much real cash is this business spitting out for me?”

Imagine you own a corner store. At the end of the year, your accountant might tell you that you made a “profit” of $50,000. But when you look in the cash register, you only have $20,000. Where did the rest go? It might be tied up in unsold inventory (Working Capital) or have been spent on a new refrigeration unit (Capital Expenditures (CapEx)). The $20,000 is your free cash flow—the real money you can take home. The FCF Yield applies this same common-sense logic to public companies. It cuts through the noise of accounting metrics like Earnings Per Share (EPS), which can be misleading. A company might look profitable on paper but be burning through cash. FCF Yield grounds your analysis in reality. Cash pays for Dividends, share buybacks, and paying down Debt; accounting profits don't. This focus on actual cash makes the FCF Yield a much more reliable cousin to the popular Earnings Yield (the inverse of the Price-to-Earnings (P/E) ratio).

There are two main ways to calculate FCF Yield, one simple and one a bit more robust. Both are useful.

This is the most common method and is perfect for a quick analysis.

• FCF Yield = Free Cash Flow (FCF) / Market Capitalization

Let's break it down:

• Free Cash Flow (FCF): This is the cash a company generates from its normal business operations, minus the money it spends on long-term assets like property, plants, and equipment (CapEx).
• Market Capitalization: This is the total value of a company's stock. You find it by multiplying the current share price by the total number of shares outstanding.

Example: If Company A generates $1 billion in FCF and its market capitalization is $10 billion, its FCF Yield is $1 billion / $10 billion = 10%.

This method is preferred by professional investors because it gives a more complete picture of the company's value.

• FCF Yield = Free Cash Flow (FCF) / Enterprise Value (EV)

The difference here is the denominator. Enterprise Value (EV) is arguably a better measure of a company's total value because it includes not just the value of its stock (market cap) but also its debt, and then subtracts any cash on the balance sheet. It tells you the theoretical takeover price—what it would cost to buy the entire business, debt and all. Using EV is like buying a house; you don't just consider the asking price, you also take on the existing mortgage. This formula shows you the cash return on the entire capital structure of the business.

Knowing the formula is one thing; using it to find great investments is another.

There's no single magic number, but here are some helpful benchmarks:

• Compare to Bond Yields: A company's FCF Yield should ideally be higher than the yield on a long-term government bond. If you can get a 4% yield from a safe government bond, you'd want a significantly higher yield, say 8% or more, from a riskier stock to compensate you for the extra risk.
• Look for High Single or Double Digits: A FCF Yield in the high single digits (e.g., 7-9%) or double digits (10%+) is often a sign of an undervalued company and is a great starting point for further research.
• Context is King: A mature, slow-growing company in the consumer staples sector will naturally have a higher FCF Yield than a fast-growing tech startup that is reinvesting every penny it makes. Always compare a company's FCF Yield to its own history and to its direct competitors.

A high FCF Yield can sometimes be a trap. Be on the lookout for:

• One-Time Windfalls: Did the company sell a factory or a subsidiary? This can create a temporary, artificial spike in FCF that won't be repeated next year.
• Underinvestment: Is the FCF high because the company has stopped investing in its future? Slashing CapEx can boost FCF in the short term but cripple long-term growth. Check if CapEx is abnormally low compared to previous years or competitors.
• Cyclical Peaks: For cyclical businesses like automakers or oil companies, FCF can be massive at the top of the economic cycle. The high yield might just be signaling that the good times are about to end.

Ultimately, FCF Yield is a powerful starting point for any serious investor. It's a cornerstone metric for many Discounted Cash Flow (DCF) models and provides a clear, cash-based view of a company's value.