The free cash flow (FCF) yield is a way to decide whether a firm is cheap or expensive based on its cash flows rather than, say, its earnings. For example, if a firm’s share price is £2.50 and it generates free cash flow per share of 50p, the yield is 20% (0.5/2.5 x 100%). The higher the yield the better value the share.
Free cash flow is the annual cash available to the directors after certain non-discretionary items have been deducted. Typically this is the firm’s operating cash flow – generated by its core business – less interest and tax payments and the amount the firm needs to spend to maintain existing fixed assets.
Like all ratios, this one is not perfect. Cash flows may be harder to manipulate than earnings but they can also fluctuate sharply from year to year. And alone, any ratio is dangerous.
• See Tim Bennett’s video tutorial: What is a cash-flow statement?