Terry Smith on the FCF yield
Terry Smith, during the Fundsmith 2013 shareholder meeting , explains the FCF yield and how he uses it as a valuation tool.
The FCF yield is the amount of cash a company generates( after all expenditures) divided by the companies enterprise value.
Shareholders own the cash flow, even if the company might not pay back all of it to us via dividends, we take the view that we own them.
Terry Smith compares the FCF yield to what he thinks the long bond yield should be .
A rational investor investor would want the yield to be 1% over the expected rate of inflation. Thus the long bond yield should be around 4% .
Thus Terry Smith will only buy companies with a FCF yield of 5% and above .

(Disclaimer: I’m not sure if Terry Smith still sticks to this method of valuation)
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MT Capital's avatar
Interesting way to think about things
Eugene Ng's avatar
I recalled he evolved that a bit over the last few years.

From his latest 2022 annual letter, the weighted average FCF yield was 2.7%.

The second leg of our strategy is about valuation. The weighted average free cash flow (‘FCF’) yield (the free cash flow generated as a percentage of the market value) of the portfolio at the outset of the year was 2.7% and ended it at 3.2%.
The year-end median FCF yield on the S&P 500 was 3.4%, roughly in line with our portfolio.
FindingCompounders's avatar
@eugeneng thanks for sharing .
Brett Schafer's avatar
This is an interesting way to think about it, but I disagree that the FCF yield should be looked at in comparison to bonds. I think it should be looked at in comparison to the returns you are looking for as an investor. It all comes down to FCF + growth in the end
Eugene Ng's avatar
@ccm_brett yes especially FCF/share growth after buybacks/dilution n

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