By Philip van Doorn
A high level of free cash flow means a company can raise dividends, buy back shares or expand. Here's how selecting stocks five years ago by FCF yield would have worked out
One measure used by analysts when selecting stocks is a company's free cash flow yield. The idea is that if a company is throwing off extra cash, the money might be used in a way that can push its stock price higher. The money might be used to fund organic expansion or acquisitions, or it might be used to raise dividends or to buy back shares. Buybacks can reduce the share count, to earnings per share and hopefully support a higher stock price.
A company's free cash flow (FCF) is its remaining cash flow after capital expenditures. You can calculate a trailing FCF yield by dividing the sum of a company's FCF per share over the past 12 months by the current share price.
You can also look at consensus estimates among analysts working for brokerage firms to calculate expected forward FCF yields. Comparing the expected FCF yields to current dividend yields will give you an estimated "headroom" figure, showing whether or not a company appears to have the ability to raise (or at least support) its current dividend payout. In December, we screened the S&P Composite 1500 Index XX:SP1500 this way to identify 11 dividend stocks with high yields that were expected to be well supported, based on consensus FCF estimates among analysts polled by FactSet.
But what if we leave dividends aside for a moment and focus only on free cash flow yields? How would stocks have performed if they were selected by this method?
A five-year backtest for stocks selected by free cash flow yield analysis
For this test, we looked back at the S&P 500 SPX to calculate trailing free cash flow yields as of April 15, 2019. We first narrowed the S&P 500 to the 487 companies that existed at that time.
When we look at FCF estimates, they aren't available for banks and insurance companies. But FactSet calculates trailing FCF per share based on companies' quarterly financial reports, including banks and insurers.
For real-estate investment trusts that own property and lease it out, funds from operations (FFO), a non-GAAP figure, is commonly used to gauge dividend-paying ability. FFO adds depreciation and amortization back to earnings, while netting-out gains on the sale of property. This can be taken further with adjusted funds from operations (AFFO), which subtracts the estimated cost to maintain properties the REITs own and rent out.
So we used FactSet's calculations for trailing FCF per share for most companies, and AFFO per share for REITs, as of April 15, 2019. Among the 487 companies, these 20 had the highest FCF yields as of April 15, 2019. None of the REITs made the list.
Company Ticker FCF yield five years ago Dividend yield five years ago "Headroom" five years ago Five-year return through April 15, 2024 Prudential Financial Inc. PRU 50.75% 3.95% 46.81% 38% Everest Group Ltd. EG 40.37% 2.48% 37.89% 78% Synchrony Financial SYF 39.33% 2.55% 36.78% 41% Capital One Financial Corp. COF 30.90% 1.84% 29.06% 75% Principal Financial Group Inc. PFG 32.71% 3.98% 28.73% 77% JPMorgan Chase & Co. JPM 27.12% 2.91% 24.21% 93% Bank of America Corp. BAC 20.88% 2.01% 18.87% 36% MetLife Inc. MET 21.32% 3.71% 17.60% 83% Discover Financial Services DFS 19.44% 2.11% 17.33% 80% Micron Technology Inc. MU 16.03% 0.00% 16.03% 196% Fifth Third Bancorp FITB 18.75% 3.24% 15.51% 56% PulteGroup Inc. PHM 16.82% 1.49% 15.33% 291% Viatris Inc. VTRS 15.02% 0.00% 15.02% -53% Aflac Inc. AFL 16.06% 2.21% 13.85% 85% Progressive Corp. PGR 14.39% 0.55% 13.84% 221% Allstate Corp. ALL 14.86% 2.07% 12.79% 95% State Street Corp. STT 15.32% 2.68% 12.64% 26% Ford Motor Co. F 19.05% 6.43% 12.62% 64% Hartford Financial Services Group Inc. HIG 14.73% 2.36% 12.37% 116% Steel Dynamics Inc. STLD 15.16% 2.85% 12.31% 369% Source: FactSet
Click the tickers for more about each company, including corporate profiles, financials, ratings, estimates and price ratios.
Only seven among this group of 20 stocks had total returns, with dividends reinvested, exceeding the S&P 500's 89% return for five years through Monday.
Then again, the average return for this group for five years was 103% - well above that of the index. And there was only one stock among the group with a negative five-year return: Viatris Inc. (VTRS).
Selecting stocks with high free cash flow yields, or at least incorporating FCF yields into a deeper process, can be considered a value-based approach that won't tap in to some of the revenue growth that has driven performance for some of the companies with the highest-weighting in the S&P 500. But it might also lead to a lower level of risk in a broad portfolio.
Don't miss:
Nvidia is the No. 1 S&P 500 growth stock in this screen. See which other companies joined or left the list.
Tomi Kilgore's detailed guide to the wealth of information available for free on the MarketWatch quote page.
-Philip van Doorn
This content was created by MarketWatch, which is operated by Dow Jones & Co. MarketWatch is published independently from Dow Jones Newswires and The Wall Street Journal.
(END) Dow Jones Newswires
04-16-24 1110ET
Copyright (c) 2024 Dow Jones & Company, Inc.
