| Type | Valuation / Quality Metric |
| Formula | FCF ÷ Market Cap |
| Strong | > 5% |
| Moderate | 3% – 5% |
| Weak | < 2% |
| Key Insight | Cash > Earnings |
formulaFree Cash Flow = Operating Cash Flow − Capital Expenditures
FCF Yield = Free Cash Flow ÷ Market Capitalization × 100
Per-share form:
FCF Yield = (FCF per Share ÷ Share Price) × 100| Company | Operating CF | CapEx | FCF | Market Cap | FCF Yield |
|---|---|---|---|---|---|
| Company A | $12B | $3B | $9B | $150B | 6.0% |
| Company B | $8B | $6B | $2B | $100B | 2.0% |
| Company C | $5B | $7B | -$2B | $80B | -2.5% |
Company A generates $9B in free cash after paying for everything. At a $150B valuation, that's 6 cents of free cash per dollar of market cap. Company C is burning cash — it spends more on capex than it generates from operations. Negative FCF yield is a red flag regardless of what the income statement says.
Earnings (net income, EPS) are an accounting construct. Free cash flow is what hits the bank account. The difference matters.
| Technique | Effect on EPS | Effect on FCF |
|---|---|---|
| Capitalize expenses instead of expensing | EPS inflated (lower current expense) | No effect — cash was spent either way |
| Aggressive revenue recognition | EPS inflated (revenue booked early) | No effect until cash is collected |
| Depreciation schedule changes | EPS changes (lower depreciation = higher profit) | No effect — depreciation is non-cash |
| Working capital manipulation | Minimal direct effect | Directly visible in operating cash flow |
| Share buybacks | EPS rises (fewer shares) | FCF decreases (cash spent on buybacks) |
formulaCash Conversion Ratio = Free Cash Flow ÷ Net Income
Healthy: > 0.80 (80%+ of earnings convert to cash)
Warning: 0.50 – 0.80 (significant non-cash earnings)
Red flag: < 0.50 (more than half of "earnings" are accounting)
Example:
Net Income: $4.2B
Free Cash Flow: $3.8B
Cash Conversion: 3.8 / 4.2 = 0.90 ← Healthy| FCF Yield | Signal | Typical Profile |
|---|---|---|
| > 8% | Deep value | Mature businesses, cyclicals at trough, or companies the market is punishing. Verify it's sustainable — could be a value trap. |
| 5% – 8% | Strong cash generator | Financials, energy majors, established tech. Good territory for income and total return investors. |
| 3% – 5% | Reasonable | Large-cap quality names. Growth reinvestment absorbs some cash. Typical for MSFT, GOOGL, JNJ. |
| 1% – 3% | Growth premium | High-growth tech, companies investing heavily in expansion. Acceptable if revenue growth exceeds 20%. |
| < 1% or negative | Cash burner | Pre-profit companies, hyper-growth with no margin, or capital-intensive businesses in build-out phase. |
referenceFCF Yield = Total cash available to shareholders
Div Yield = Cash actually distributed to shareholders
The gap between them is the "retained firepower":
FCF Yield: 6.0%
Div Yield: 2.5%
Retained: 3.5% → Available for buybacks, debt paydown,
acquisitions, or future dividend raises.
A company cannot sustainably pay dividends exceeding its
FCF yield. If Div Yield > FCF Yield, the dividend is funded
by debt or asset sales. That's a cut waiting to happen.| Sector | Typical FCF Yield | Why |
|---|---|---|
| Energy | 7% – 12% | Cash-heavy at high commodity prices. Low reinvestment rates at mature fields. |
| Financials | 6% – 10% | Low capex, high operating leverage. FCF is essentially net income for banks. |
| Healthcare | 4% – 7% | Patent-protected margins generate substantial cash. R&D is expensed, not capex. |
| Consumer Staples | 4% – 6% | Predictable demand, low capex needs, steady margin structure. |
| Technology | 2% – 5% | Asset-light but often reinvesting aggressively. Wide range depending on maturity. |
| Utilities | 1% – 3% | Massive capex on infrastructure. Regulated returns limit free cash. |
formulaAdjusted FCF = Operating Cash Flow
− Capital Expenditures
− Stock-Based Compensation
This penalizes companies that "pay" employees with equity
(diluting existing shareholders) instead of cash.
Example (heavy SBC company):
Operating CF: $18B
CapEx: $6B
SBC: $8B
Standard FCF: $18B - $6B = $12B
Adjusted FCF: $18B - $6B - $8B = $4B
Standard FCF Yield at $300B market cap: 4.0%
Adjusted FCF Yield: 1.3% ← Very differentpseudocodeScreen for cash generators:
1. Filter: FCF Yield > 4%
2. Filter: FCF positive for 5 consecutive years
3. Filter: Cash Conversion Ratio > 0.80
4. Filter: Market cap > $10B
5. Sort: FCF Yield descending
Pair with:
- P/E < 20 (not overpaying on earnings either)
- PEG < 1.5 (growth is reasonably priced)
- Debt/Equity < 1.5 (not leveraged to the gills)FCF yield tells you the total shareholder return capacity. How the company allocates that cash defines the investment thesis:
| Allocation | Effect | Best For |
|---|---|---|
| Dividends | Direct income. Taxed immediately. | Income investors, retirees. |
| Share buybacks | Increases EPS, supports price. Tax-deferred. | Growth investors in taxable accounts. |
| Debt paydown | Reduces interest expense, lowers risk. | Deleveraging thesis, credit improvement. |
| Reinvestment (R&D, capex) | Grows future earnings. No immediate return. | Growth investors with long time horizon. |
The ideal is a company with 6%+ FCF yield that pays 2-3% as dividend, buys back 1-2% of shares annually, and reinvests the rest. That's a compounding machine.
Earnings yield is the accounting-based cousin of FCF yield. Comparing the two reveals earnings quality — a wide gap means accounting profit isn't converting to cash.
PEG adjusts P/E for growth. Pair it with FCF yield to confirm the growth is cash-backed, not just accounting-driven.
Higher FCF yield names support larger position sizes. Cash generation reduces downside risk and funds shareholder returns.