Free cash flow yield definition
/What is Free Cash Flow Yield?
Free cash flow yield compares an organization’s free cash flow per share to its market price per share. A low ratio is good for the investor, since the market price is being supported by a significant amount of cash flow. In this situation, there is room for the market price of the stock to increase. In the reverse situation, a high ratio means that a market price is not being supported by much cash flow, so the market price is more likely to stay flat or decline. However, free cash flow can vary significantly over time, so it makes sense to view this measurement on a trend line to gain a better understanding of how it has varied in the recent past.
How to Calculate Free Cash Flow Yield
To calculate free cash flow yield, divide the free cash flow per share by the current share price. Free cash flow is the net change in cash generated by the operations of a business during a reporting period, minus cash outlays for working capital, capital expenditures, and dividends during the same period. The formula is:
Free cash flow per share ÷ Current share price = Free cash flow yield
Example of Free Cash Flow Yield
As an example of free cash flow yield, a business generates annual free cash flow of $1 billion, and has a market capitalization of $10 billion. Based on this information, the organization generates a free cash flow yield of 10%, which indicates that the company generates free cash flow equivalent to 10% of its market capitalization annually. This is generally viewed as attractive if it is higher than the yields of other investment options, such as bonds or similar companies in the industry.
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FAQs
How Does Free Cash Flow Yield Differ from Earnings Yield?
Free cash flow yield measures the cash a company generates after capital expenditures relative to its market value, while earnings yield measures net income relative to market value. Because free cash flow reflects actual cash available to investors, it often provides a clearer picture of financial strength than net income, which can be affected by non-cash items and accounting policies. Many investors prefer free cash flow yield since it shows how much real cash the business produces to support dividends, buybacks, or debt repayment.