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)