How to Calculate Free Cash Flow Yield

Get educated on free cash flow yield and the ETFs that can profit from it.

kent
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Research Lead
Reviewed by: Lisa Barr
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Edited by: Lisa Barr

Free cash flow yield can provide investors a valuable perspective on a company's cash flow generation. We dig deeper to understand how free cash flow yield works, how to calculate it and what investors can learn from the metric. We also highlight some of the top free cash flow ETFs on the market. 

What Is Free Cash Flow Yield? 

Free cash flow yield (FCFY) is a financial metric that measures the profitability of a company relative to its market value. It focuses on the cash flow generated by a company rather than its accounting profits, which can be subject to various noncash items and accounting adjustments. 

Free cash flow yield is often used by investors as an alternative valuation measure to traditional metrics like price-to-earnings (P/E) ratio. 

How Is Free Cash Flow Yield Calculated? 

Free cash flow yield is calculated by dividing a company's free cash flow per share by its market price per share and expressing the result as a percentage. 

The formula for free cash flow yield is as follows: 

Free Cash Flow Yield = (Free Cash Flow per Share / Market Price per Share) x 100 

In this calculation, free cash flow per share represents the amount of cash generated by a company's operations that is available to be distributed to investors, after deducting capital expenditures and working capital requirements. Market price per share is the current trading price of the company's stock. 

What Is a Free Cash Flow ETF? 

A free cash flow ETF is an exchange-traded fund that focuses on investing in companies with strong free cash flow characteristics. These ETFs typically select companies based on their ability to generate positive and growing free cash flow, which represents the cash remaining after deducting capital expenditures from operating cash flow. 

Top Free Cash Flow ETFs 

Free cash flow ETFs may follow various investment strategies and approaches. Some ETFs may track an index that includes companies with high free cash flow generation, while others may employ active management to select stocks based on their free cash flow metrics.  

The top free cash flow ETFs, as measured by AUM as of June 30, 2023, include: 

  • Pacer U.S. Cash Cows 100 ETF (COWZ): One of the fastest-growing ETFs, COWZ tracks a free-cash-flow-weighted index of companies selected from the Russell 1000 Index, providing broad-based U.S. largecap equity exposure with the investment thesis that higher free cash flow is a mark of stability. AUM for COWZ is $13.36 billion and its expense ratio is 0.49%. 
  • Pacer U.S. Small Cap Cash Cows 100 ETF (CALF): Starting with the S&P Small Cap 600 Index, CALF screens out financial companies except for REITs and companies projected to have negative free cash flows or earnings in the next two years. AUM for CALF is $2.55 billion and its expense ratio is 0.59%. 
  • Pacer Global Cash Cows Dividend ETF (GCOW): This free cash flow ETF tracks an index of developed-market large cap stocks, selected by free cash flow yield and dividend yield, and weighted by aggregate dividends. To do this, the fund first screens out stocks with negative free cash flow or earnings and excludes REITS altogether. It ranks the remaining stocks by free cash flow yield (FCF/EV), culling the top 300 names. AUM for GCO is $1.65 billion and its expense ratio is 0.60%. 
  • Distillate U.S. Fundamental Stability & Value ETF (DSTL): This ETF is an actively managed fund that screens the 500 largest U.S.-listed stocks for 100 firms that score highly on fundamental metrics, primarily free cash flow. The AUM for DSTL is $1.0 billion and its expense ratio is 0.39%. 

What Conclusions Can Be Drawn From FCFY? 

Free cash flow yield provides investors with insights into a company's ability to generate cash flow relative to its market value.

Here's what free cash flow yield can tell you: 

  • Profitability and cash generation: Free cash flow yield offers a measure of a company's profitability and cash generation capabilities. By focusing on the cash flow generated after accounting for capital expenditures and working capital requirements, it provides an indication of how efficiently a company can convert its operations into cash. 
  • Relative valuation: Free cash flow yield helps investors assess the attractiveness of an investment opportunity by comparing a company's cash flow generation to its market price. A higher free cash flow yield implies that investors are paying a relatively lower price for each unit of cash flow generated, potentially indicating a more favorable valuation. 
  • Financial health: Free cash flow yield is an indicator of a company's financial health and its ability to meet various financial obligations. Companies with a consistently positive and growing free cash flow yield may be better positioned to fund future investments, pay down debt and distribute dividends to shareholders. 
  • Dividend sustainability: Free cash flow yield can provide insights into a company's ability to sustain and potentially increase dividend payments to shareholders. A higher free cash flow yield suggests that a company has more available cash to allocate toward dividends, which can be an attractive feature for income-seeking investors. 
  • Long-term viability: By focusing on cash flow generation, free cash flow yield offers a perspective on a company's long-term viability. Sustainable and growing free cash flow indicates that a company has the financial resources to invest in future growth, adapt to changing market conditions and weather economic downturns. 

Levered vs. Unlevered Cash Flow Yield 

Levered and unlevered cash flow yield are two variations of the free cash flow yield metric that provide different perspectives on a company's cash flow generation.  

Here's an explanation of each: 

Levered Cash Flow Yield 

Levered cash flow yield, also known as equity cash flow yield or equity yield, measures the return on investment for equity shareholders after accounting for the company's debt and interest expenses. It focuses on the cash flow available to equity investors. 

The formula for levered cash flow yield is as follows: 

Levered Cash Flow Yield = (Free Cash Flow to Equity / Market Value of Equity) x 100 

In this calculation, free cash flow to equity represents the cash flow generated by the company that is available to be distributed to equity shareholders (after servicing debt and interest expenses). The market value of equity is the total market value of a company's outstanding shares. 

Levered cash flow yield is useful for equity investors who are specifically interested in evaluating the return on their investment after accounting for the company's leverage and related costs. 

Unlevered Cash Flow Yield 

Unlevered cash flow yield, also known as enterprise cash flow yield or total cash flow yield, measures the return on investment for all capital providers (both equity and debt) before accounting for interest expenses and debt obligations. It focuses on the cash flow generated by the overall operations of the business. 

The formula for unlevered cash flow yield is as follows: 

Unlevered Cash Flow Yield = (Free Cash Flow to the Firm / Enterprise Value) x 100 

In this calculation, free cash flow to the firm represents the cash flow generated by the company's operations before interest expenses and tax obligations. Enterprise value is a measure of the total value of a company's equity and debt, taking into account its market capitalization, debt and other financial liabilities. 

Unlevered cash flow yield provides a broader perspective on the company's cash flow generation, as it considers the returns available to both equity and debt investors. It can be useful for investors who want to evaluate the overall profitability and cash flow potential of a business, regardless of its capital structure. 

Both levered and unlevered cash flow yield can be valuable metrics in assessing the cash flow generation of a company. However, it's important to note that levered cash flow yield is specific to equity investors, while unlevered cash flow yield provides a more comprehensive view that includes all capital providers. The choice between the two depends on the investor's specific focus and objectives. 

How Does Cash Flow Differ From Earnings? 

Cash flow and earnings are both important financial metrics that provide insights into a company's financial performance, but they represent different aspects of a company's operations.  

Here's how they differ: 

  • Cash flow: Cash flow refers to the actual movement of cash in and out of a company during a specific period. It represents the cash generated or consumed by a company's operating activities, investing activities and financing activities. 
  • Earnings: Earnings, also known as net income or profit, represents the company's revenue minus its expenses and taxes. It is calculated based on accrual accounting principles and reflects the profitability of a company over a specific period. 

It's important to note that while earnings are a crucial measure of profitability, cash flow provides additional information about a company's liquidity, cash management and ability to fund its operations. Both metrics are important for a comprehensive understanding of a company's financial performance, and they should be considered together when evaluating investment opportunities. 

Bottom Line 

Free cash flow yield provides a valuable perspective on a company's cash flow generation, but it should not be the sole basis for investment decisions. Investing in free cash flow ETFs can provide exposure to companies with healthy cash flow generation, which can indicate financial strength, operational efficiency and the ability to fund growth initiatives, pay dividends or reduce debt.  

As always, investors should consider factors such as risk tolerance and market conditions before buying shares of these funds. 

Kent Thune is Research Lead for etf.com, focusing on educational content, thought leadership, content management and search engine optimization. Before joining etf.com, he wrote for numerous investment websites, including Seeking Alpha and Kiplinger. 

 

Kent holds a Master of Business Administration (MBA) degree and is a practicing Certified Financial Planner (CFP®) with 25 years of experience managing investments, guiding clients through some of the worst economic and market environments in U.S. history. He has also served as an adjunct professor, teaching classes for The College of Charleston and Trident Technical College on the topics of retirement planning, business finance, and entrepreneurship. 

 

Kent founded a registered investment advisory firm in 2006 and is based in Hilton Head Island, SC, where he lives with his wife and two sons. Outside of work, Kent enjoys spending time with his family, playing guitar, and working on his philosophy book, which he plans to publish in the coming year.