By comparing free cash flow to market capitalization (shares outstanding x price of stock) you produce a percentage of return on the value of stock that can be used to enhance shareholders. This could include dividends, stock buybacks, reduction in debt, or additional investments (i.e. acquisitions).
Free Cash Flow Yield is awarded 9 out 34 valuation points in our Dividend Analyzer analysis.
Now one step further:
Net Free Cash Flow Yield
Net Free Cash Flow makes further allowances for the current portion (1 year) of long term debt, and dividends the company currently intends to pay.
Net Free Cash Flow (NFCF) = Free Cash Flow (FCF) – current portion of long term debt – current portion of future dividends (1 year).
I don’t find Net Free Cash Flow used too much, possibly because its similar to Free Cash Flow.
Importance of Free Cash Flow
Free Cash Flow is a part of analyzing the strength and health of a company. A company with a negative free cash flow may not have the liquidity to stay in business without obtaining additional cash through borrowing or raising equity capital. Declining cash flows are a warning sign that the company future earnings may not be able to grow.
A company with positive net free cash flow is generating the cash needed to pay operating bills, meet working capital requirements, pay taxes, meet current interest and debt payments, invest in capital expenditures, and pay dividends. Rising cash flows can indicate a company is healthy and many times precedes increasing earnings and enhanced shareholder value.
Free Cash Flow Yield determines if the stock price provides good value for the amount of free cash flow being generated. In general, especially when researching dividend stocks, yields above 4% would be acceptable for further research. Yields above 7% would be considered of high rank.
The following post was republished with permission from Arbor Investment Planner.