Key variable: free cash flow yield.
Free cash flow (FCF) is one of the most important financial metrics you can study – especially if you’re a buy-and-hold investor. Free cash flow is the amount of money generated from a company’s operations minus any capital expenditures; it is the cash remaining after a company has paid its expenses, interest on debt, taxes, and long-term investments to grow its business.
Suppose a company generates more cash than it needs to run its business. In that case, it can do several valuable things, such as pay dividends, buy back its stock, acquire other companies, expand its business, and knock out its debts.
Free cash flow yield is thus free cash flow per share divided by the stock’s price.
By looking at operating earnings, free cash flow takes out one-time gains or losses that may obscure the actual state of a company’s business. It’s also less susceptible to the accounting gimmicks impacting a company’s reported earnings.
Many of the greatest investors consider free cash flow yield a key factor in analyzing a stock. There are limitations to any single metric, and free cash flow per share and free cash flow yield are no exceptions to that rule.
A company, for example, can have an extremely high free cash flow in part because it is putting off necessary capital expenditures. Similarly, a good company that makes significant capital investments one year may see its free cash flow take a hit but may benefit over the longer haul. That’s why it’s important to consider free cash flow along with a stock’s other fundamentals.
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