Free Cash Flow Yield
Free Cash Flow Yield (FCF Yield) is a financial solvency ratio that compares the free cash flow per share a company is able to generate against its market value per share. The FCF Yield is used to determine the return on investment for the company. It’s a measure of how well a company generates cash flow relative to its market valuation.
The formula to calculate Free Cash Flow Yield is as follows:
\(\text{Free Cash Flow Yield} = \frac{\text{Free Cash Flow}}{\text{Market Capitalization}} \)
Alternatively, it can also be calculated on a per share basis:
\(\text{Free Cash Flow Yield} = \frac{\text{Free Cash Flow per Share}}{\text{Market Capitalization}} \)
Here:
- Free Cash Flow (FCF) is the cash a company generates through its operations, less any capital expenditures.
- Market Capitalization is the total dollar value of all of a company’s outstanding shares of stock, calculated as the share price multiplied by the number of shares outstanding.
- Free Cash Flow per Share is the free cash flow divided by the number of outstanding shares.
- market Price per Share is the current market price of the company’s stock.
A higher FCF Yield can indicate that a company is undervalued and generating a good amount of cash flow relative to its market value, which could make it a potential investment opportunity. However, like all financial metrics, it’s important to compare the FCF Yield with industry peers and consider it in the context of other financial indicators and company-specific factors.
Example of Free Cash Flow Yield
Suppose we have a hypothetical company, XYZ Corp., and we want to calculate its Free Cash Flow Yield. Here is the relevant financial information:
- Free Cash Flow (FCF) for the past year: $2,000,000
- The company’s Market Capitalization: $20,000,000
We can calculate the Free Cash Flow Yield as follows:
\(\text{Free Cash Flow Yield} = \frac{\text{Free Cash Flow}}{\text{Market Capitalization}} \)
So, substituting in the given values:
\(\text{Free Cash Flow Yield} = \frac{\$2,000,000}{\$20,000,000} = \text{= 0.1 or 10%} \)
So, XYZ Corp.’s Free Cash Flow Yield is 10%.
This means that for every dollar of market value, XYZ Corp. generated 10 cents of free cash flow over the past year. This figure would be used by investors to compare the company’s performance with other investment opportunities or similar companies in the market. A higher Free Cash Flow Yield might indicate a potentially undervalued company, assuming other factors remain constant.
