Free Cash Flow and FCF Yield, From the Cash Flow Statement

Two companies each report net income of $50 million. The first brought in $70 million of cash from its operations during the year, spent $15 million on equipment, and finished with $55 million it could hand to shareholders or lenders without borrowing a cent. The second collected $40 million. Then it poured $30 million into a new plant, leaving $10 million. On an earnings screen the two look identical.

Earnings rest on accruals and judgment calls. Cash is what moved through the bank account. Free cash flow measures the second. It comes straight off the cash flow statement in the 10-Q or 10-K.

Working it from the statement

The cash flow statement starts with net income and adjusts it. Non-cash charges like depreciation get added back. Money tied up in inventory and receivables gets subtracted. The result is cash from operations, sometimes labeled net cash provided by operating activities.

Capital expenditures sit lower down in the investing section, usually labeled as purchases of property and equipment, and most filings print them as a negative number, so subtract their size and be careful not to add a negative twice.

FCF yield

Free cash flow in dollars tells you nothing about price. FCF yield does. Divide free cash flow by market capitalization, or do the same thing per share by dividing FCF per share by the share price, and you get a number you can hold up against a bond yield, a dividend yield, or the same company’s yield five years ago.

Both routes give the same answer when the share count matches. They drift apart when a tool mixes diluted and basic share counts. A higher yield means you pay less for each dollar of cash the business throws off, though it can also mean the market expects that cash to shrink, so the yield on its own settles nothing.

Stock-based compensation

Analysts disagree on this line. Paying staff in stock costs no cash. Accounting adds it back in operating cash flow, like depreciation. Your ownership still gets diluted, though, and a company that pays heavily in stock often spends real cash on buybacks just to hold the share count steady. Some analysts therefore subtract stock-based compensation from free cash flow.

At a manufacturer the gap is modest, while at a software firm that pays a large slice of its wages in stock the adjusted figure can be a fraction of the headline one, so check which version your screen is showing before comparing two companies. The share count and dilution show the same cost from the other side.

Lumpy capex

Capital spending arrives in bursts. A company builds a plant one year and then coasts on it for three. One year can look far too good or too bad.

The single best year says $55 million. The average says $40 million. Use several years. Read the filing to learn whether the big year was a one-off.

Against net income

Put free cash flow next to net income for the same years. When they track each other over time, the earnings are backed by cash. A company whose free cash flow runs well below net income for several years is either investing heavily or booking profits it has not collected, and the notes on receivables and inventory usually tell you which. The gap between cash flow and earnings deserves its own look. Free cash flow well above net income is the reverse case. It often comes from heavy depreciation on old assets that will need replacing.

Where it shows up and how tools differ

Quote pages put free cash flow on the cash flow tab, often with a trailing twelve month figure next to the annual columns, and screeners usually add FCF per share, FCF yield and price to free cash flow, which is the yield turned upside down. Definitions vary. Some tools subtract all capex. Others try to split maintenance spending from growth spending, and a few count stock pay as a cost. Levered free cash flow means interest is already paid. Your screener’s glossary should give the formula. If it does not, rebuild one year from the filing and compare.

Using it

Dividends come out of free cash flow. The cash payout ratio is built on it. It is also the input a discounted cash flow model projects forward, which is covered in estimating fair value with a DCF and can be tried in the DCF calculator. For screening, a positive FCF yield across three or more years, with free cash flow roughly keeping pace with net income, filters out a lot of companies whose profits exist mainly on paper. Then open the cash flow statement and look at the capex line yourself.