Free Cash Flow Yield

Free cash flow yield expresses a company's free cash flow as a percentage of its stock price. It answers a practical question: for every dollar I invest in this stock, how much actual cash does the underlying business generate per year?

The formula divides free cash flow per share by the current stock price and multiplies by 100. A stock trading at 50 dollars with free cash flow of 4 dollars per share has an 8 percent free cash flow yield.

Reading the Signal

Free cash flow yield above 8 percent generally signals an attractively priced stock, though it may also indicate elevated risk. The range of 5 to 8 percent is considered solid for most established companies. Below 3 percent suggests the stock is expensive relative to the cash it actually generates. Negative yield means the company is consuming more cash than it produces.

Free cash flow yield is harder to manipulate than earnings-based ratios because it measures real cash. A company can inflate accounting earnings through aggressive revenue recognition or capitalizing expenses, but cash either arrives in the bank account or it does not.

Comparing a stock's free cash flow yield to the current government bond yield provides a quick sanity check. If a stable company yields less free cash flow than a risk-free bond, investors are paying a steep premium for future growth that may or may not materialize.