Free cash flow yield

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.

Cash flow is vital because if a business runs out of cash it will go bust, even if it appears to be making a decent profit on paper. Hence the oft-quoted business cliché, “cash is king”. Reporting of cash flows is also harder to manipulate in a flattering manner than reporting on earnings (which can be heavily influenced by choice of accounting conventions). This is one reason why investors should look at company valuation using measures based on cash flow as well as those based on profits or book value.

With that in mind, the free cash flow yield (FCFY) is a ratio used to work out the cash flow return on a share as a percentage. Mechanically, if free cash flow is, say, £100m, and the firm’s market capitalisation (the number of shares in issue multiplied by the current price) is £500m, then the FCFY is 20% ((100/500)* 100%).

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