Analysts frequently turn to a key metric when assessing a company’s financial health and potential for growth: free cash flow (FCF) yield. FCF represents the cash remaining after a company has covered capital expenditures, such as investments in property or equipment. Investors carefully consider FCF yield as it signals a company’s ability to pursue opportunities. Whether that means increasing dividends, repurchasing shares to boost earnings per share, funding expansion, or pursuing strategic acquisitions, a robust FCF yield can be a clear sign of a business operating from a position of strength.
How Does FCF Yield Drive Stock Performance?
To better understand the potential of investing in high FCF-yield stocks, we conducted an in-depth analysis, looking back five years within the S&P 500. One of our analysts meticulously calculated trailing free cash flow yields as of April 15, 2019. For companies in sectors where FCF estimates aren’t readily available, such as banking and insurance, trailing FCF per share was derived from quarterly financial reports.
In the real estate sector, REITs (Real Estate Investment Trusts) operate with different metrics. Analysts generally focus on funds from operations (FFO) and adjusted funds from operations (AFFO). These figures offer insights into a REIT’s capacity to sustain its dividend distributions. For this analysis, we incorporated AFFO per share for REITs for a comprehensive evaluation.
The Results: High-Yielders and Market Performance
After careful calculations, a select group of 20 stocks emerged with the highest FCF yields within the S&P 500 as of April 15, 2019. Interestingly, REITs did not feature in this top tier.
A fascinating outcome of our analysis was that, over the subsequent five-year period, slightly over a third of these high-FCF-yield companies outperformed the broader S&P 500’s impressive 89% total return (assuming reinvested dividends). However, the average return for this elite group was a remarkable 103%, comfortably surpassing the market benchmark.
It’s worth noting that within this group, only one company, Viatris Inc., failed to produce a positive return over the five-year span. This suggests that a strategy prioritizing companies with strong FCF yields can deliver remarkable results, potentially with a reduced risk component compared to solely chasing high-growth stocks.
Analyst Insights: Balancing Growth and Stability
One of our analysts highlighted that selecting stocks solely based on free cash flow yield does, undoubtedly, have its trade-offs. This approach might overlook certain fast-growing companies that propel much of the S&P 500’s gains. However, a focus on FCF yield can create a portfolio that balances the pursuit of growth with a degree of stability and resilience.
Another analyst commented that the ability to generate ample free cash flow is often indicative of a company with a strong competitive position. Companies with solid FCF can invest in their businesses even during challenging economic environments, giving them a potential advantage over their competitors.
The Takeaway
While a strategy based solely on FCF yield might not be a guaranteed ticket to market-beating returns, our analysis demonstrates that it can be a powerful tool for investors seeking a blend of value and growth potential. By carefully considering FCF yield alongside other fundamental metrics, and incorporating insights from professional analysis, investors may position themselves well for long-term success in an ever-changing market.
