Free cash flow yield, or FCFY, is a measure of a company's fiscal health. It also indicates how well an investment in the company is performing. Like the price-to-earnings ratio, or PE, it may also signal investors that a company's stock is overvalued or undervalued. Some analysts consider the FCFY a better evaluation tool than the PE ratio.
Definition and Uses of Cash Flow Yield
The formula for cash flow yield is:
Annualized free cash flow divided by market capitalization
Calculating Free Cash Flow Yield
Determining Cash Flow From Operations
For a relatively powerful analysis tool, calculating FCFY is surprisingly easy. You begin by determining how much cash is on hand after the company pays its bills from its accounting statement of cash flow, which shows the beginning and ending values. Generally financial professionals add back revenues and expenses that don't produce actual inflows and outflows to the company's net income to determine cash flow. Revenues that are included are cash receipts from sales of goods or services as well as income from interest. Outflows that are included are inventory costs, payroll, taxes and operating costs including utilities, maintenance and rent.
An easy way to come at this number is to look at the company's income statement to find net income, then add back expenses that don't actually change the cash on hand, such as depreciation. The result is the company's total free cash flow for the accounting period.
Calculating Company Value
Calculating the company's value is also straightforward. First, determine the current share price, which you can find online or from a financial daily, and the total shares outstanding. You can find the latter value on the company's balance sheet, sometimes identified as capital stock. The total of all shares are also referred to as total market capitalization. Multiplying the share price by the total number of shares outstanding gives you the company's value.
Using the Data to Calculate Free Cash Flow Yield
To determine the free cash flow yield, you can divide the total cash flow from operations by the company's value or you can make the same calculation for each share. In that case, the free cash flow yield is a yield per share and is determined by dividing the free cash flow per share by the value of that share. The result is the same in both cases and is always a percentage.
An analysis of Apple (AAPL) on May 20, 2015, for example, gives the total operating cash flow as $76.31 billion and the total market cap -- its total value based on the shares outstanding -- as $749.38 billion, with a resultant free cash flow yield of 76.31/740.38, or 10.18 percent. This is generally considered a healthy number and is an improvement on an earlier analysis in December 2014, which determined that the free cash flow yield at that time was only 7.15 percent -- a percentage that the analyst concluded was an indication that the stock was overvalued and should be sold.
The Limits of Data Analysis
Determining free cash flow yield is often useful for anyone trying to determine whether to buy or sell a stock, but the Apple results from December 2014, when the FCFY was 7.15 percent -- considered a sell signal -- to May 2015, when it reached a FCFY of more than 10 percent shows why data analysis of stocks is always less than certain. On the day of the earlier December 28, 2014, analysis, AAPL closed at $113.99. On May 20, 2015, it closed at $130.06. If you had taken the earlier FCFY ratio to heart and sold, by May 20 you would have missed out on a 14 percent gain.
I am a retired Registered Investment Advisor with 12 years experience as head of an investment management firm. I also have a Ph.D. in English and have written more than 4,000 articles for regional and national publications.