We are updating the Free Cash Flow Yield calculation used in our Stock Ratings and ETF & Mutual Fund Ratings to use a new calculation that:
- removes the impact of changes in cash balances from the calculation of Free Cash Flow and
- uses a 2-year average Free Cash Flow value.
Before this update, Free Cash Flow Yield in our Stock and Fund Ratings was calculated as:
Free Cash Flow / Enterprise Value.
After this update, the FCF Yield calculation that we use in our ratings will be:
2-Year Average Free Cash Flow (excluding cash) / Enterprise Value.
This update to our Free Cash Flow Yield calculation improves the metric in two key ways:
- Removes the impact of cash from the calculation of Free Cash Flow: The original version of Free Cash Flow = NOPAT – Change in Invested Capital. This update eliminates the impact of all cash line items (e.g. new cash raised from selling shares, acquiring new debt, or changes to our required cash assumption) on Free Cash Flow. The goal for this update is to focus more on the underlying economics of the business.
- Uses a 2-year average for Free Cash Flow: A 2-year average limits the year-to-year volatility of Free Cash Flow and provides a more normalized assessment of the business. A single-year Free Cash Flow is more easily distorted by one-time events such as large asset purchases or other large outlays.
We expect this update to impact Overall Stock Ratings as follows:
- Improve one level for 88 companies
- Worse by one level for 91 companies
- Worse by two levels 1 companies.
These Overall Stock Rating changes are driven by changes in our underlying Free Cash Flow Yield rating (one of the five metrics that make up our Overall Stock Rating). FCF Yield ratings are expected to change as follows:
- Better for 553 companies
- Worse for 753 companies.
In addition to the updates to our ratings, we are also adding “all cash” and “no cash” versions of several metrics in our Company Model. The “all cash” versions will include all of a company’s cash, not just the required cash in the calculation of the metrics. The “no cash” versions will remove all cash from the calculations. Institutional members will find “all cash” and “no cash” versions of the metrics below in our Company Models on the ROIC, Free Cash Flow, and Economic Earnings pages:
- NOPAT
- Invested Capital
- ROIC
- Free Cash Flow
- Economic Earnings
Providing the two new versions of these metrics allows investors to analyze the economics of companies through multiple lenses. No two companies are the same, and no single metric perfectly captures the economics of every company. That’s why we provide multiple versions of metrics using our proven-superior fundamental data.
We expect these changes will be live on our site on July 18, 2024.
This article was originally published on July 15, 2024.
Disclosure: David Trainer, Kyle Guske II, Hakan Salt, and Robbie Woodward receive no compensation to write about any specific stock, sector, style, or theme.
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