Free cash flow yield10/6/2023 Unlike market cap, the enterprise value takes account preferred shares, debt, and cash. = Market Cap + Preferred Shares + Net Debt If we look at the definition of enterprise value, this makes sense intuitively.Įnterprise Value = Market Cap + Preferred Shares + Debt – Cash Whilst this metric also performs well in backtests, it just isn’t any match for the EV version. Price-to-free-cash flow is the reciprocal of the free cash flow yield in this case and is calculated on a per share basis. The EV version performs better in backtests than the MC version.Īs an aside, when we use market cap in the denominator, we are essentially looking at the standard price-to-free-cash flow measure. You will notice enterprise value (EV) in the denominator of the free cash flow yield instead of market cap (MC). Image free to use with credit to The Sovereign Investor and a dofollow link to This article by Yuval Taylor at Portfolio123 gives a great analysis of the different variations of free cash flow and free cash flow yield. Note we are referring to the trailing 12-month free cash flow here. ![]() Free Cash Flow and Free Cash Flow Yield Definitionįree Cash Flow = Cash From Operations + Int(1 – t) – CAPEX = NOPAT + Depreciation – Change in Net Working Capital – CAPEXįree Cash Flow Yield = Free Cash Flow/Enterprise Value This is where the famous statement “CASH IS KING” comes from. There is nothing management can do to distort this. Even sales can be slightly manipulated through accrual accounting.Ĭash at the end of a financial period will always equal cash at the beginning plus or minus any cash made or lost during the period. It is a ‘clean’ measure of a company’s earnings power, as there are no ways to manipulate it with clever accounting tricks like you can with earnings or book value. It should come as no surprise that free cash flow is the go-to value metric for elite investment professionals. I’ve been following him for a long time, and it’s always stuck with me how he values his portfolio with the free cash flow yield. Terry Smith is CIO of the Fundsmith Equity Fund, which has an enviable track-record. Not only does this ratio produce extraordinary profits in backtests, but it is also the preferred metric of heavyweight investors such as Terry Smith. Having backtested numerous value strategies over long periods of time and in different stock markets, there is one ratio that consistently stands out. ![]() Wouldn’t it be great if there was one metric superior to the rest? Not only that, but legendary investors such as Warren Buffett and Benjamin Graham are living proof of its efficacy.īut with so many different ways to define ‘value’, how should we know which metric to use? It is one of the most well-established investment strategies with an impressive track-record of beating the market.Ĭountless academic studies have documented this long-term outperformance. We are all familiar with the concept of value investing – buying shares that are ‘cheap’ relative to some underlying measure of fundamental value.
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