Definition
Free Cash Flow Yield (FCFY) is a financial solvency ratio that compares the free cash flow per share a company is able to earn against its market share price. It’s an indicator of the company’s ability to generate cash and is often used by investors to measure the value of a company. The higher the FCFY, the better the return on investment for shareholders.
Key Takeaways
- Free Cash Flow Yield (FCFY) is a financial performance ratio that measures how well a company generates cash from its operations. It is calculated by dividing free cash flow per share by the current market price per share.
- It provides a more direct measure of a company’s profitability than earnings per share since it’s based on actual cash flow, rather than accounting profits. Therefore, it is a valuable tool for investors since it allows a direct measurement of the return on their investment.
- A high FCFY can indicate that a company is undervalued, offering potential for a higher rate of return. On the contrary, a low FCFY might suggest that a company is overvalued, indicating a potentially lower return on investment.
Importance
Free Cash Flow Yield (FCFY) is an important finance term because it serves as a financial performance indicator that provides insights into a company’s operational efficiency and financial health.
Unlike other financial metrics, FCFY considers both the company’s earnings and the cash it generates after accounting for capital expenditures.
It helps investors to gauge a company’s profitability and its potential for growth because it reflects the actual cash available for distribution to investors after all expenses, debts, and reinvestment needs are met.
Thus, FCFY is a critical measure used in assessing the performance, stability, and future growth prospects of a company or security, aiding investors to make informed investment decisions.
Explanation
The purpose of Free Cash Flow Yield (FCFY) is to measure a company’s financial performance and provide an insight into its profitability. It is a valuable tool for investors and financial analysts to evaluate whether a company generates enough cash flow to maintain, expand operations, and return profits to stakeholders.
This financial metric offers a more direct reflection of the cash profits available to the firm in relation to the market value. Unlike earnings or net income, free cash flow is a measure of profitability that eliminates the non-cash expenses and includes expenditure on equipment and assets necessary for business growth.
Free cash flow yield is extensively used in considerations of business acquisitions, as it demonstrates how much cash an investor will get back for each dollar invested. It’s also used to determine a company’s ability to pay dividends, repay debt, and carry out other transactions that could potentially benefit a shareholder.
It can be used to compare the relative attractiveness of investments in different industries or sectors, as it mitigates the impact of differing company size and industry-specific requirements. Therefore, FCFY provides a clear view of a company’s health by indicating its financial flexibility and capacity to generate shareholder returns.
Examples of Free Cash Flow Yield (FCFY)
**Apple Inc**: As of Q3 2021, Apple’s free cash flow yield is calculated at around23%. This is derived from its free cash flow of approximately $67 billion over its market capitalization of $58 trillion. This implies that if the company were to use all its free cash flow to pay back investors, they would receive a
23% return on their investment, making it a relatively lower risk investment.**Tesla Inc**: For the year ending 2020, Tesla Inc. had a free cash flow of $79 billion and its market capitalization for the same period was approximately $668 billion. This resulted in a free cash flow yield of around
42%. This indicates that investing in Tesla is comparatively riskier due to its lower FCFY.**Amazon Inc**: For the year ending 2020, Amazon’s free cash flow amounted to $4 Billion, while its market capitalization stood at $
56 trillion, revealing a free cash flow yield of69%. This gives investors an insight into the efficiency of Amazon’s cash generation and its potential returns. Although not necessarily high, it denotes stability in Amazon’s business operations. These investigations of FCFY in companies are necessary for investors to assess the financial health and profitability of these firms. More free cash flow means the company is generating more cash that can be invested, saved, or returned to shareholders.
Free Cash Flow Yield (FCFY) FAQ
What is Free Cash Flow Yield (FCFY)?
Free Cash Flow Yield (FCFY) is a financial valuation ratio that indicates the percentage of a company’s market value that is generated by cash flows from its operations. It measures the ability of a company to generate cash and is considered a better measure of profitability than earnings yield because cash flows cannot be easily manipulated with accounting techniques.
How is FCFY calculated?
FCFY is calculated by dividing the Free Cash Flow per share by the current market price per share. The formula is: FCFY = (Free cash flow / Market capitalization) * 100%. The result is expressed as a percentage.
What does a high FCFY indicate?
A high FCFY ratio suggests that the company is generating more cash flow relative to its market value, which may be a positive signal to investors. It could mean that the company is undervalued, and thus may represent a good investment opportunity.
What does a low FCFY indicate?
A low FCFY ratio could mean that the company is overpriced relative to its cash flows. In other words, the company might be overvalued, implying that it might not be a great investment opportunity.
What is the difference between FCFY and dividend yield?
Whilst both are financial ratios that investors use to evaluate a company’s performance and financial health, they measure different things. FCFY measures the percentage of a company’s market value that’s generated by cash flows from its operations, whereas the dividend yield is the financial ratio that shows how much a company pays out in dividends each year relative to its stock price.
Related Entrepreneurship Terms
- Cash Flow
- Free Cash Flow (FCF)
- Enterprise Value (EV)
- Net Income
- Cost of Capital
Sources for More Information
- Investopedia: A comprehensive website with easy-to-understand articles and videos on a wide array of financial topics including Free Cash Flow Yield (FCFY).
- Corporate Finance Institute (CFI): An online educational platform that provides detailed information and courses on various finance topics.
- The Motley Fool: An investment advice website providing plethora of resources on investing and financial terms which includes FCFY.
- Seeking Alpha: A crowd-sourced content service for financial markets offering articles and research tools on a broad range of financial topics.
