![]() ![]() Only normalized book to market (inverse of price to book) would have given you slightly higher returns compared to the one year ratio. The Spread (Value-Growth) part of the table shows the difference between the Equal Weight Value and Equal Weight Growth returns of the two above tables.Īs you can see (look at the dark green areas of the table) they did not find that using normalized ratios can add to your returns. The Equal Weight Growth part of the table shows the equal-weighted returns of the most overvalued (expensive) 20% of companies based on each valuation ration. The Equal Weight Value part of the table shows the equal-weighted returns of the most undervalued (cheap) 20% of companies based on each valuation ration. ![]() Source: Analyzing Valuation Measures: A Performance Horse-Race over the past 40 Years. Portfolios were re-balanced on a yearly basis.įor the one year (1yr) ratios companies were selected based on current numerator (top value) and current denominator (bottom value) for each measure.įor all the normalized ratios (2 years – 8 years) they used the average of the numerator over the past 2 to 8 years, and divided this average by the current denominator.įor example, the 8 year FCF/EV ratio was calculated using the average of the past 8 years FCF for each company (including the current year), and dividing this by the company’s current total enterprise value (EV).They only included companies for which 8 years of data was available.Portfolios were put together on 30 June each year when all the companies were sorted into five quintiles – 20% groups of companies.This back test excluded financial companies and utilities, and the smallest 10% of market value companies listed on the NYSE.Book to market(B/M) – the inverse of Price to Book.Gross profits to total enterprise value (GP/TEV).Free cash flow to total enterprise value (FCF/TEV) – FCF was defined as Net Income + Depreciation and Amortization - Working Capital Change - Capital Expenditures.Earnings before interest and taxes and depreciation and amortization to total enterprise value (EBITDA/TEV).Earnings to Market Value (E/M) – You can also call the ratio Earnings to Price – the inverse of the PE ratio.They also tested normalized (average) ratios to see if they increase returns. They tested 5 ratios over the 40 year period from 1 July 1971 to 31 December 2010 to find the best valuation ratio. Luckily the great guys at Alpha Architect tested not just free cash flow yield but also normalized (average) valuation ratios in a paper called Analysing Valuation Measures: A Performance Horse-Race over the past 40 Years written by Wes Gray and Jack Vogel. Only once you have answered these questions is it a good idea to invest your hard earned money using the strategy.Ĭlick here to get the tools you need to implement a high FCF yield strategy in your portfolioĭoes free cash flow yield investing work in the USA?įirst let’s find out if free cash flow yield works in the USA. In the Quant Investing stock screener we define Free Cash Flow (FCF) as: Total Cash from operations (from the company’s Cash Flow Statement) Minus Capital Expenditure (also from the Investing section of the Cash Flow Statement)Īnd we define Free Cash Flow Yield as: Free Cash Flow (as calculated above) Divided by Enterprise Value.Įnterprise Value (EV) is defined as the current market value of the company (market capitalisation) + Long-Term Debt + Minority Interest + Preferred capital - Excess Cash.īefore you use any investment strategy the most important question you should ask yourself is does it work over long periods of time?Īnd if it works in one stock market over one time period does it work in other stock markets in different time periods. What is free cash flow and free cash flow yieldīefore we go any further let’s make sure we know what we are talking about. There is not much management can do to manipulate these numbers, except through outright fraud – this means it is a good way to value a company. It's a “ clean” valuation ratio because cash in the company’s bank accounts at the beginning of the financial year plus or minus the cash the business made or loss must be equal to the cash in the bank accounts at the end of the year. Using a high free cash flow yield investment strategy makes a lot of sense because it is a “ clean” valuation ratio you can use to find undervalued companies. Why free cash flow yield is a great investment strategy The best Free Cash Flow Yield investing stock ideas for 2021 will be grouped as follows: It also shows you how to improve the strategy and exactly how to implement a Free Cash Flow Yield investment strategy in your portfolio. ![]() This article gives you the best Free Cash Flow Yield investment strategy stock ideas for 2021. ![]()
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