What is Free Cash Flow Yield?

Definition: Free cash flow yield, or FCF yield, is a valuation metric to measure the yield of a firm’s free cash compared to its size.

What Does Free Cash Flow Yield Mean?

What is the definition of free cash flow yield? FCF is a useful valuation metric to determine a firm’s operating performance. Generally, firms with strong cash flows are financially healthy as opposed to firms with weak FCFs may be unable to meet their short-term obligations.

The FCFY provides an additional indication of a firm’s operating strength by comparing the free cash flows to the market cap. As expected, a low FCFY indicates a firm in which investors are putting more money than the returns it generates. Financial analysts investigate FCF yield along with a firm’s capital expenditures to determine whether potentially weak FCFs can be justified by investments in fixed assets.

Let’s look at an example.

Example

Mary works as an accountant in a retail company. She is asked to calculate the free cash flows formula of the company for the period 2010 – 2015 and determine whether the FCFY is attractive.

Mary calculates the FCFs as follows:

Then, she finds the stock’s historical prices for the relevant years and the number of shares outstanding to calculate the market cap.

So, based on Mary’s calculations, in 2010, the company had 750,000 shares outstanding, which traded at \$35.85, hence a market cap of \$26.9 million. As it can be seen, the market cap decreases in 2012 and in 2013, thereby affecting the firm’s cash flows. Apparently, the firm had released negative results or had failed in a project to the extent that it could not generate strong cash flows as in 2010.

Mary calculates the FCFY of each year by dividing the free cash flow over the market cap.

However, to get a firm idea of how strong or weak is the FCFY, financial analysts compare it to a benchmark firm in the industry.

Summary Definition

Define Free Cash Flow Yield: FCF Yield means a financial measurement designed to evaluate a firm’s profitability and efficiency.