Definition
Free Cash Flow Yield (FCF Yield) is a financial solvency ratio that measures the expected free cash flow per share of a company against its market value per share. It is calculated using the formula:
$$
\text{Free Cash Flow Yield} = \frac{\text{Free Cash Flow per Share}}{\text{Market Price per Share}}
$$
In simple terms: it tells you how well a company is generating cash relative to what you’re paying for a piece of it.
| Free Cash Flow Yield |
Earnings Yield |
| Focuses on cash flow: cash in hand that is available for payment to investors or reinvestment. |
Focuses on profit: potentially includes accounting tricks and is less indicative of cash position. |
| Formula: FCF / Share Price |
Formula: Earnings / Share Price |
| Reflects true liquidity |
Reflects accounting profit |
| Often more stable: cash tends to have less volatility than earnings. |
Can be influenced by accounting practices: What goes up must also go down, like a yo-yo! |
Example Calculation
If a company has a free cash flow of $1,000,000 and there are 1,000,000 shares outstanding, then:
$$
\text{Free Cash Flow per Share} = \frac{1,000,000}{1,000,000} = 1
$$
If the current share price is $20:
$$
\text{FCF Yield} = \frac{1}{20} = 0.05 \text{ or } 5%
$$
This means for every dollar you invest, you potentially receive 5 cents in free cash flow. Not too shabby unless you’re investing in a chocolate fountain—as those typically don’t yield cash!
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Earnings Yield: The earnings per share of a company divided by its market price per share; it’s like the cousin who focuses on earnings rather than cash.
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Free Cash Flow: The cash generated by a company after accounting for capital expenditures. It’s the cash left over for Rah-Rah’s and table dances after all the bills are paid!
Humorous Insight
“Walt Disney once said, ‘The way to get started is to quit talking and begin doing.’ Imagine if you told your investors that your free cash flow yield was just a myth—talk about a scary Halloween special!” 🎃
Frequently Asked Questions
-
Why is Free Cash Flow Yield important?
- It provides insights into a company’s ability to generate cash after accounting for capital expenditures, indicating financial health and value.
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How is Free Cash Flow Yield different from Dividend Yield?
- Free Cash Flow Yield measures cash generated, whereas Dividend Yield measures actual cash returned to shareholders.
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Can a company have a high free cash flow yield but still face financial problems?
- Yes, because a high yield does not guarantee good management or lack of hidden liabilities!
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Is a high FCF Yield always good?
- Not necessarily! Sometimes it indicates a lack of growth opportunities that could be attractive to other investors.
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How can I use Free Cash Flow Yield in my investment decisions?
- Compare the FCF Yield of companies in the same industry to find where you can get more bang for your buck!
References and Resources
Test Your Knowledge: Free Cash Flow Yield Quiz
## What does Free Cash Flow Yield tell you?
- [x] How much cash a company generates relative to its stock price
- [ ] The amount of debt a company has
- [ ] The dividends paid out to shareholders
- [ ] The total profit a company made last quarter
> **Explanation:** Free Cash Flow Yield indicates how efficiently a company generates cash relative to its market value.
## If a company's Free Cash Flow Yield is 8%, what does this mean?
- [ ] For every dollar invested, you get 8 cents in cash
- [x] For every dollar invested, you get 8 cents in free cash flow
- [ ] This company is bankrupt
- [ ] You should run for the hills
> **Explanation:** An 8% yield indicates that for every dollar invested, there's a potential 8 cents in free cash flow to reinvest or distribute.
## What is NOT a benefit of Free Cash Flow Yield?
- [x] It gives an accurate representation of future earnings
- [ ] It compares cash flow with share price
- [ ] It helps evaluate a company's financial health
- [ ] It sheds light on the company's ability to reinvest
> **Explanation:** Free Cash Flow Yield does not guarantee insights into future earnings as it focuses on cash flow at present.
## Which formula represents Free Cash Flow Yield?
- [ ] FCF x Market Price
- [ ] FCF / Total Assets
- [x] FCF / Market Price
- [ ] Market Price / Total Liabilities
> **Explanation:** The correct formula for FCF Yield is Free Cash Flow divided by Market Price per Share.
## A company has a Free Cash Flow of $500,000 and a market cap of $2,500,000. What is the FCF Yield if there are 500,000 shares outstanding?
- [ ] 2%
- [ ] 10%
- [x] 20%
- [ ] 30%
> **Explanation:** First, calculate FCF per share: $500,000 / 500,000 = $1. Then, FCF Yield = $1 / ($2,500,000 / 500,000) = 1 / 5 = 20%.
## How do you interpret a declining FCF Yield?
- [ ] The company is becoming more profitable
- [x] It might be struggling to generate cash flow or its stock price is rising too quickly
- [ ] The company is a cash-generating machine
- [ ] It’s time to celebrate!
> **Explanation:** A declining FCF Yield means the company is either generating less cash or investors are paying too much for the stock—never a reason to celebrate!
## Which statement is true regarding Free Cash Flow Yield?
- [x] It is indicative of a company's ability to generate cash
- [ ] It provides guarantees on future dividends
- [ ] It only considers profits from operations
- [ ] It reflects only short-term cash generation
> **Explanation:** FCF Yield reflects the company's real cash generation and its potential to reward shareholders.
## True or False: The Free Cash Flow Yield is quite similar to the concept of earnings yield.
- [x] True
- [ ] False
> **Explanation:** True, both metrics give insights about the returns, but FCF Yield looks at cash whereas earnings yield focuses on profits.
## Which metric can be considered more reliable for assessing a company’s financial flexibility?
- [x] Free Cash Flow Yield
- [ ] Price to Earnings Ratio
- [ ] Return on Equity
- [ ] Gross Margin
> **Explanation:** FCF Yield is more reliable than others when evaluating a company’s ability to generate cash and manage liabilities.
## What's the key drawback of using Earnings Yield over Free Cash Flow Yield?
- [x] Earnings yield can be skewed by accounting policies
- [ ] Earnings yield always overestimates value
- [ ] Earnings yield is never used in finance
- [ ] Earnings yield gives information on cash reserves
> **Explanation:** Earnings yield can be manipulated due to accounting practices, making it less reliable than Insightful Cash Flow Yield.
Thank you for diving into the world of Free Cash Flow Yield! May your investments flow like cash and return faster than a speeding bullet! 💸
