What is Free Cash Flow Yield?

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Free cash flow yield is a financial solvency ratio that compares the free cash flow per share a company is expected to earn against its market value per share. The ratio is calculated by taking the free cash flow per share divided by the current share price. Free cash flow yield is similar in nature to the earnings yield metric, which is usually meant to measure GAAP (generally accepted accounting principles) earnings per share divided by share price.

Definition

Free cash flow yield is a financial solvency ratio that compares a company's expected free cash flow per share to its market value per share. This ratio is calculated by dividing the free cash flow per share by the current stock price. Similar to the earnings yield metric, it is commonly used to measure the ratio of earnings per share calculated according to generally accepted accounting principles to the stock price.

Origin

The concept of free cash flow yield originated from a deeper analysis of a company's financial health, particularly in the late 20th century when investors and analysts began to focus more on cash flows rather than just accounting profits. As capital markets evolved, investors realized the importance of free cash flow as it directly impacts a company's ability to service debt and return value to shareholders.

Categories and Features

Free cash flow yield can be categorized into two types: positive free cash flow yield and negative free cash flow yield. A positive free cash flow yield indicates that a company has sufficient cash flow to pay off debts and distribute dividends, while a negative free cash flow yield may suggest that a company needs to borrow or issue new shares to sustain operations. The main feature of this ratio is that it provides a more realistic view of a company's financial condition as it takes into account changes in capital expenditures and working capital.

Case Studies

Case Study 1: Apple Inc. in 2019 demonstrated a strong free cash flow yield, indicating that it had ample cash flow to pay dividends and repurchase shares, which boosted investor confidence and drove up its stock price. Case Study 2: Tesla, in its early development stages, showed a negative free cash flow yield due to heavy investments in production facilities and R&D. However, over time, Tesla's free cash flow yield improved, reflecting the maturation of its business model and enhanced profitability.

Common Issues

Investors might encounter issues when using free cash flow yield, such as accurately calculating free cash flow, especially with differences in accounting standards. Additionally, relying too heavily on this ratio might overlook other important financial metrics, such as debt levels and market competition.

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