Latest / Stock Picking with Fexingo: Individual Equities, Research, and Building a Concentrated Portfolio / How to Value High Free Cash Flow Yield Stocks
Transcript
- Lucas: Apple's up eight-point-eight percent in the last five trading days. Microsoft, four-point-seven. The megacaps are ripping again, and I keep hearing people say these stocks are too expensive to buy. But expensive relative to what? Luna: Relative to earnings, sure. But I think there's a better metric for this moment. Free cash flow yield. Lucas: Exactly. And I want to spend today on that single number, because it's one of the most honest signals you can get from a financial statement. Free cash flow yield tells you how much cash a company generates per dollar of its stock price. It's the inverse of the price-to-free-cash-flow ratio. Luna: So if a stock trades at fifty dollars and generates five dollars per share in free cash flow, the yield is ten percent. Simple. Lucas: Right. And the beauty is that free cash flow is harder to manipulate than earnings. You can smooth earnings with depreciation estimates or revenue recognition policies, but cash is cash. It either came in or it didn't. Luna: So where does Apple land on that metric? It's up huge this week, but it's also sitting on a mountain of cash. Lucas: Apple's trailing twelve-month free cash flow is roughly one hundred and ten billion dollars. Market cap around three point nine trillion. That gives you a free cash flow yield of about two-point-eight percent. Not terrible for a company with Apple's competitive position, but it's not screaming value either. Luna: Compare that to the ten-year Treasury, which is yielding around four-point-three percent. So you're getting less cash yield from Apple than from a risk-free government bond. Lucas: That's the tension right now. Investors are paying a premium for quality and growth. But if you're a disciplined stock picker, you want to find companies where the free cash flow yield compensates you for the risk. And those companies usually aren't the largest names. Luna: So where do you look? Small caps? The Russell 2000 is actually down half a percent over the last five days. Lucas: It is, and that's interesting because many small and mid-cap stocks have higher free cash flow yields on paper. But you have to be careful. A high free cash flow yield can also be a value trap if the cash flow is declining. Luna: Right. A company with shrinking free cash flow and a falling stock price can show a rising yield, but it's not a buy signal. Lucas: Exactly. So you need to look at the trend. I like to see at least three years of growing free cash flow per share. And I want the free cash flow yield to be above the company's cost of capital. Luna: Let's talk about Berkshire Hathaway. It's up one-point-eight percent this week, but it's sitting on over three hundred billion in cash. That cash doesn't earn much, so it drags down the free cash flow yield of the operating businesses. Lucas: That's a great point. Berkshire's free cash flow yield on an operating basis is probably around five or six percent, but when you factor in the cash pile, the overall yield is lower. Buffett has essentially been saying he can't find enough attractively priced stocks to deploy that cash. That's a signal. Luna: It's a signal that the market is expensive overall. When Berkshire is hoarding cash, it's worth paying attention. Lucas: And that's why free cash flow yield is so useful as a market-level indicator too. If you screen the S&P 500 for stocks with a free cash flow yield above five percent, you get a much smaller universe today than you would have in 2022. The median free cash flow yield for the index is probably around three and a half percent. Luna: So the bar is low. But you can still find individual names. Lucas: Absolutely. And here's where it gets practical. I want to give listeners a simple framework. First, calculate free cash flow yield. Second, compare it to the company's five-year average. Third, check if free cash flow per share has grown over the last three years. If the yield is above the five-year average and cash flow is growing, you have a potential buy. Luna: What about companies that pay dividends or buy back stock? Does that change the math? Lucas: It does. You can think of the total cash return yield, which adds dividends and buybacks and divides by market cap. But free cash flow yield is the raw material. A company can only pay dividends and buybacks if it has free cash flow. So I start with free cash flow yield, then look at payout ratios. Luna: I know a lot of our listeners are individual investors. They might not have access to Bloomberg terminals. How can they calculate this? Lucas: You can get free cash flow from a company's cash flow statement, which is in every quarterly report on the SEC's EDGAR system. Or use a screener like Finviz or Yahoo Finance. They often list free cash flow and shares outstanding. Divide free cash flow per share by the stock price, and you have your yield. Luna: And you can do that in under five minutes. That's the kind of work that separates a thoughtful investor from someone just buying the hype. Lucas: Speaking of separating hype from reality — I want to be honest with our listeners about something. This show exists because of a small group of people who chip in monthly through buy me a coffee dot com slash fexingo. No ads, no sponsors, no corporate agenda. Just straightforward stock-picking conversations. Luna: Yeah, and we keep it that way intentionally. If you've found value in episodes like this one, that's the mechanism that keeps it going. No pressure, just a fact. Lucas: Exactly. And back to free cash flow yield — let's talk about a real example that I think is underfollowed right now. Look at a company like Microsoft. Its free cash flow yield is around two-point-five percent, which is low. But Microsoft's free cash flow has grown at about twelve percent compounded annually over the last five years. So the yield today understates the future yield if growth continues. Luna: So you're saying a low free cash flow yield today can be justified if the cash flow is growing fast enough. Lucas: Right. That's the growth-adjusted free cash flow yield. You can estimate next year's free cash flow based on the growth rate and then calculate the forward yield. If Microsoft grows free cash flow by twelve percent, the forward yield becomes about two-point-eight percent. Still low, but better. Luna: But if you're looking for a double-digit free cash flow yield today, you're probably not looking at megacap tech. You're looking at energy or maybe some beaten-down industrials. Lucas: Exactly. ExxonMobil has a free cash flow yield around eight percent. Chevron is around seven percent. But those yields are tied to oil prices, which are volatile. So you have to ask whether the free cash flow is sustainable. Luna: And that brings us back to the trend. If free cash flow per share has been growing through the cycle, you have more confidence. Lucas: Precisely. The framework works across sectors. The key is to compare the free cash flow yield to the company's cost of capital and its own history. If the yield is higher than the cost of capital and above the historical average, you're getting a margin of safety. Luna: I like that this metric forces you to think like an owner. You're asking: how much cash does this business throw off relative to what I'm paying? Lucas: Exactly. And that's the core of stock picking. Not price momentum, not analyst upgrades, but cash. Because in the end, a stock's value is the present value of all future free cash flow. If you can buy a dollar of future cash flow for fifty cents today, you have a good investment. Luna: And if you can't find those opportunities, maybe it's time to hold more cash. Like Berkshire. Lucas: Right. The best stock pickers know when to be patient. Free cash flow yield helps you see when the market is giving you a deal and when it's asking you to pay up.