Free Cash Flow And FCF Yield

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Free cash flow (FCF) equals the amount of cash free for distribution to all stakeholders. Think of free cash flow as the real dividend that a company could pay investors as well as a truer proxy for the profitability of a business. Not surprisingly, many of the world’s top investors focus on free cash flow when picking stocks.

There are many ways to calculate free cash flow. Most approaches are short cuts to a more comprehensive approach to the calculation. Our formula for FCF is in Figure 1.

Figure 1: How to Calculate Free Cash Flow

NOPAT – Change In Invested Capital


Sources: New Constructs, LLC and company filings

As with all things in life, building a solid investment strategy around Free Cash Flow (FCF) is not as simple as it may seem. While it is obvious that companies with larger and growing FCF should fetch higher valuations, making money with that strategy requires a bit more work.

Here are 3 rules to follow when building an investment strategy that uses FCF.

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