Video Tutorial: Welcome to our third session on screening, and this week we’re going to be using free cash flow yield ratios to find undervalued stocks.
When analysing a cash flow, what you really want to see is free cash flow within the business. That’s the key from a value investing perspective. Free cash flow is a measure of a company’s financial performance, by looking at their operating cash flow from their income statement minus their capital expenditures. It’s really important, because it allows the company to grow by pursuing opportunities that allow it to further grow shareholder value (dividends, acquisitions, etc.). This free cash flow yield is really the driver of shareholder value, which is why it’s what we look for.
Why Is Free Cash Flow Important? [Video Tutorial]
Analysing Free Cash Flow: Levered and Unlevered
On the STRIDE platform, we look for free cash flow in two ways: 1) Levered (factoring in the cash required to service debt), 2) Unlevered (not factoring in the cash required to service debt). If you want to fast-track your analysis, I’d recommend rather looking at the levered view, because we do want to see what influence a company’s debt has on its shareholder value (which we can’t see with the unlevered view). You can access these views in our platform by searching for each of them in the “Add a financial filter” search bar, while editing your STRIDE screen.
Using the Levered Free Cash Flow Margin
Now, when analyzing free cash flows, we’re really more interested in ratios and percentages, because if you’re looking at a diverse number of companies they likely report in different currencies, use different scales, etc. Ratios are the best way to cut through these differentiators and allow us to fairly compare many companies.
So that’s why we’ll first look at a company’s levered free cash flow margin. Now, the range of the free cash flow margin can be altered in your screen to filter companies that don’t match your investor’s profile, but that’s really up to you and your aims. Obviously, you will be looking for a positive margin, and use this is as a comparison tool to weigh companies against each other.
How to Calculate Cash Flow from Operations
The ratio, Cash Flow to Current Liabilities, is important, because it makes sure that the cash generated from current operations in the company covers the current set of bills that need to be paid (liabilities). Ideally, you’d want this cash to more than cover the bills, and so it’s best to set minimum range of this ratio to “1”, to exclude any companies who don’t make the cut (again, this can obviously change depending on your specific goals and needs as an investor).
Levered Free Cash Flow 1YR Growth % and Levered Free Cash Flow 5YR CAGR %
Now, with these, you want to see that the company's free cash flow yield is growing well, and consistently. At a very basic level, you want to see that the company is at least growing beyond the inflation rate. If you’re not sure how to judge this, you can watch our previous week’s video or read the blog on how to analyse an income statement.
Next week, we’ll be pulling together these 3 tutorials in one large screen. We won’t be using any of the unnecessary fields or duplicated fields that we’ve covered through these 3 weeks, but we’ll build out a filtered view of around 20-30 companies that are undervalued and good buys, according to the STRIDE Screener.
If you’d like to try the STRIDE Screener out for yourself, sign up for a free live demo below.