FCF Yield vs. Multiple
Wondering what the pros/cons are of using FCF or Earnings Yield. When would it be most appropriate to use a FCF/Earnings yield rather than a multiple? Or is it just another valuation/sanity check method. Would appreciate any thoughts.
Yield is the inverse of multiple. For example a 5x P/E ratio is equivalent to saying a 20% earnings yield. A 10x FCF multiple is equivalent to a 10% FCF yield.
Mathematically these are inverse, but reflect different viewpoints or approach - yield based tend to focus more on the numerator eg quality of FCF while taking the market value in the denominator as a given/input; multiple based goes the opposite, given x earnings.
Happy for others to critique my view above.
As others have said, there is quite literally no difference between FCF yield and multiples
FCF yield and earnings yield are not the same. The only thing they have in common is the denominator (market cap).
Earnings yield = EPS / Share Price
FCF Yield = Levered FCF / Share divided by Share Price
EPS doesn't tell you how much cash the company actually generated in the period of time, but FCF does. In fact, I'd argue that FCF is a much superior metric to look at as it strips out all the financing, investing, operating activities associated with running a business, and really tells you how much cash is available to the equity holders i.e. can be paid in the form of dividends. FCF yield is a valuation methodology similar to others (EV/ Revenue, EV/ EBITDA, EV/EBIT). At the end of the day, what matters to me about a business is its FCF generation (i.e. EBITDA to FCF conversion), and so I'd argue that a company which has a high FCF yield should trade at a higher multiple relative to its peers (all else equal).
Thanks for this. Maybe I am misunderstanding, but in this last sentence, do you mean company's that have higher FCF CONVERSION should trade at higher multiples? Because if FCF yield increases, doesn't that mean the multiple automatically decreases (since they are reciprocals)?
FCF yield has to do with the value of the company, while FCF conversion has to do with the % of EBITDA that remains as FCF. So higher conversion -> superior business -> higher multiple (other things equal). That is consistent with [multiple =inverse of yield].
I am not sure if I fully understood the last bit of your question, and so let me repeat: Companies that have high FCF conversion / generation should trade at a higher FCF multiple in my books.
Let me illustrate this with an example from a deal I worked on as an analyst. A telco company that we were selling was trading at a very slight premium to its peers when we analyzed its EV / EBITDA, EV / EBIT multiples. But this company had a high FCF generation relative to peers and when we looked at its FCF multiple (Price / FCF), it was trading at a 10% discount to its peers. And so obviously, like any good ibanker, we argued that our client was much superior to its competition, and so it should generate a much higher premium than what the market is giving credit for. I don't want to get into the "efficient market hypothesis" argument here, but markets are seldom efficient. If they were efficient, there would be no need for value investors. I am obviously oversimplifying here as there were many other things that were a part of the analysis. But I hope you got my point. All the best.
That's a typo on the previous poster's part. A company which has high FCF conversion on EBITDA should trade at a higher multiple (lower FCF yield). A company with high FCF yield should trade at a lower multiple because mathematics of reciprocals lol.
They are reciprocals as others have said. I personally like looking at yield because it can be benchmarked to fixed income yields more easily and then makes more intuitive sense to me.
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