Definition
Free Cash Flow Yield is a financial solvency ratio that compares the free cash flow per share a company is expected to earn against its market value per share. It is calculated by taking the free cash flow per share divided by the current market price per share. This ratio is used to determine the value of a company by showing how much cash a firm can generate in relation to its current stock price.
Phonetic
The phonetic pronunciation of “Free Cash Flow Yield” is “free kash floh yeeld.”
Key Takeaways
“`html
- Indicator of Return Value: Free Cash Flow Yield is a critical financial indicator. It helps to determine the return value an investor receives from their investments. This is a significant measurement for assessing an investment’s profitability and viability.
- Comparison Benchmark: Free Cash Flow Yield is a potent tool for comparing the value of different companies within the same industry. It’s an efficient way to contrast a firm’s cash efficiency against its competitors, providing necessary context for the overall health and competitiveness of a business.
- Assessment of Financial Health: Since Free Cash Flow Yield incorporates total debt and cash flows from operations, it gives an insightful understanding of a company’s financial health. High Free Cash Flow Yield values may indicate robust financial health, while low values might suggest potential financial difficulties or less efficiency in generating cash.
“`
Importance
Free Cash Flow Yield is an important business/finance term as it is a fundamental indicator of a company’s financial health, providing insights into the actual cash a company has available to investors and showing its profitability. It provides a direct measure of the return on investment that an investor is making with respect to the free cash available to be distributed among all securities holders, such as stockholders and debt holders. By understanding and comparing the Free Cash Flow Yield figures of multiple companies, investors can make informed decisions regarding their investment strategies. Unlike earnings or net income, free cash flow is harder to manipulate, making it a reliable metric for evaluating a company’s financial stability.
Explanation
Free Cash Flow Yield is an important financial metric that investors and market analysts use to assess the financial strength and profitability of a business. Instead of relying entirely on earnings, which may sometimes be manipulated through legal accounting tactics, Free Cash Flow Yield helps investors get a more accurate picture of a company’s actual ability to generate cash. The measurement provides insights into the value of the company by comparing the cash it generates to its market capitalization. This aids in indicating whether a company is over or under-valued, thus providing investors with potential investment opportunities.In essence, the Free Cash Flow Yield is predominantly used in investment analysis for evaluating the attractiveness of an investment or in the comparison of different investment opportunities. The higher a company’s free cash flow yield, the better it can be deemed for investors, as it reflects the company’s capability to expand its operations, reduce debt, pay dividends, and survive economic downturns. Thus, Free Cash Flow Yield can be regarded as a fundamental performance indicator for an investor to measure a company’s financial health and investment attractiveness.
Examples
Free Cash Flow Yield (FCFY) is a financial solvency ratio that compares the free cash flow per share a company is expected to earn against its market value per share. Here are three real-world examples related to this term:1. Alphabet Inc. (Google’s parent company): The company has consistently generated positive free cash flows over the years. As of 2020, Alphabet’s FCF was $42.2 billion. If the market value of Alphabet Inc. is $1.5 trillion, the FCFY would be calculated as (42.2 billion/1.5 trillion) *100 = 2.81%. This would mean every dollar invested in Alphabet Inc. has $0.0281 in Free Cash Flow.2. Microsoft: The tech giant is known for its high FCFY. For example, if it had a free cash flow of $33.6 billion in 2020, and a total market value of about $1.8 trillion, its FCFY would be (33.6 billion/1.8 trillion)*100 = 1.87%. A high FCFY like this signifies that Microsoft is using its capital efficiently and creating returns for its shareholders. 3. Johnson & Johnson: A multinational corporation dealing in medical devices, pharmaceutical, and consumer packaged goods. Suppose it had a free cash flow of $20.2 billion and a market capitalization of $400 billion for its last fiscal. The FCFY for Johnson & Johnson would be (20.2 billion/400 billion)*100 = 5.05%. This high Free Cash Flow Yield suggests that the pharmaceutical giant is performing well in generating cash after paying off its capital expenditures.These examples show how Free Cash Flow Yield can be used to evaluate the performance of different companies. Please note the FCFY percentages given above are for illustrative purposes and not exact calculations based on current figures.
Frequently Asked Questions(FAQ)
What is Free Cash Flow Yield?
Free Cash Flow Yield or FCF yield is a financial solvency metric that compares a company’s free cash flow per share to its share price. It is indicative of the amount of free cash flow (profit) a company is generating compared to its market capitalization.
How is Free Cash Flow Yield calculated?
The formula for Free Cash Flow Yield is Free Cash Flow per Share divided by the current market price of the stock. You can also multiply this ratio by 100 to express it as a percentage.
What does a high Free Cash Flow Yield infer?
A high Free Cash Flow Yield indicates that the company is generating more cash than is required to cover its costs and dividends, leaving a surplus that can be used for other activities such as acquisitions, debt reduction, or return to shareholders.
What does a low Free Cash Flow Yield mean?
A low FCF Yield might mean that the company is not generating enough cash to cover its expenses and dividends. This could signal financial distress, and it might result in reduced dividend payments or increased debt.
Can Free Cash Flow Yield be negative?
Yes, Free Cash Flow Yield can be negative if the company’s free cash flow is negative. This might happen if the company has high capital expenditures or if it’s not making enough revenue to cover its operating expenses.
How does Free Cash Flow Yield differ from Dividend Yield?
While both metrics provide insights into a company’s financial health, they are different. Dividend Yield is the ratio of the company’s annual dividend to its share price. On the other hand, Free Cash Flow Yield compares the company’s free cash flow per share to its share price. Both are important, but they offer different perspectives.
Is a higher Free Cash Flow Yield always better?
While a higher Free Cash Flow Yield can indicate a company’s profitability, it should not be the only metric considered when evaluating a company. Other factors, such as the company’s growth prospects, debt levels, and the overall state of the economy, should also be taken into account.
Related Finance Terms
- Operating Cash Flow: It represents the cash from a firm’s regular operations without considering investments or changes in capital structure.
- Capital Expenditure (CapEx): The funds spent by a company for the maintenance or enhancement of its business operations, often in the forms of property, plants, and equipment.
- Enterprise Value (EV): A measure of a company’s total value, often used as a more comprehensive alternative to equity market capitalization.
- Cash Flow Yield: It assesses the price of a stock or a bond relative to its annual cash flow.
- Price-to-Free Cash Flow: A ratio that compares a company’s market price to its level of free cash flow, thus providing a measure of a firm’s investment attractiveness.
